Transcript Perfect Competition

Perfect Competition
Outline
•Competition and socially efficient resource
allocation
•Structural features of competitive markets
•The supply curve of the competitive firm
•Consumer and producer surplus
•The market for daycare
Socially Optimal Resource Allocation
To say that the scheme of
resource allocation is
“socially optimal” means that
a re-allocation of resources
could not make any one
person better off without
making at least one other
person worse off.
We can trust market forces to
allocate resources in a socially
optimal way—that is, if markets are
“competitive” in structure.
If markets are
“imperfectly”
competitive in
structure, then
all bets are off.
Structural features of
competitive markets
1. Large number of buyers and sellers
2. No barriers to entry
3. Homogeneous or standardized product
4. Buyers and sellers are “price takers.”
Short run supply curve for the
competitive firm
The supply curve for the
firm is given by MC above
the minimum of AVC.
MC
ATC AVC
Output (Thousands of Units)
Demand curve facing the
competitive firm
Revenue per unit
$6
Competitive firm faces an
infinitely elastic demand
curve at the market
determined price
P = AR = MR
Output (Thousands of Units)
Competitive firm can earn an economic
profit in short run
Cost and Revenue per Unit
MC
AC
P = $8.00
AC = $6.50
P = MR
Q=6
Output (Thousands of Units)
(a) A Competitive Firm's Optimal Output
Price
S1
S2
$8.00
The opportunity
to earn an
economic profit
attracts new firms
to the market
$6.50
D
Entry shifts the
market supply
curve to the right
Quantity
Economic profits eroded by entry
Cost and Revenue per Unit
MC
AC
P = $6.00
P = MR
Q=5
Output (Thousands of Units)
(b) Long-Run Equilibrium in a Competitive Market
Effect of a change in demand before and
after entry
Cost and Revenue per Unit
D
$8
P = $6
$4
0
D'
Supply curve
before entry
E'
E
E*
Supply curve
after entry
D
D'
100 200 240 280
Output (Thousands of Units)
The Invisible Hand
According to Adam Smith1,
even self-centered people like
me are led by the “invisible
hand” of competition to
promote the best interests of
society.
1Adam
Smith. The Wealth of Nations, 1776
What assumptions must one
make about the structure of
markets to “prove” that the
market system produces socially
efficient resource allocation?
Modern welfare economics has
this all worked out.
Why competitive markets are efficient
Competitive markets provide
efficient amounts of goods and
services at minimum cost to the
consumers who are most willing
(and able) to pay for them.
Samuelson and Marks (1999, p. 330).
Consumer and Producer Surplus
•Consumer surplus (CS) is the difference
between the maximum amount the consumer is
willing to pay for a given quantity of a good or
service rather than go without it and what they
actually pay for a given quantity of the good or
service.
•Producer surplus (PS) is the difference
between the minimum price a seller would have
to get to offer a given quantity of goods and
services and the price the seller actually gets for
that quantity.
You’re paying $2.69 for a
gallon of gas—but I bet you
would be willing to pay more
rather than go without it. If
so, there you derive a surplus
on the transaction.
Example: The Demand
and Supply of Day Care
oThe Palmers are willing to pay a maximum
of $8 per hour for daycare (10 hours per
day) for their two year old.
oA grandmother in the neighborhood is
willing to provide the service. Her minimum
acceptable fee is $4 per hour.
Daycare transaction
Dollars per Hour
Couple's
maximum
value
Price
$8
Consumer surplus
$20 per week
6
Producer surplus
$20 per week
Grandmother's 4
cost
If the negotiated price is $6,
then each party gets a
surplus of $20 per week
2
0
2
Q
4
6
8
10 12
Hours of Day Care per Week
The Regional Market for Daycare
Hourly Price
$14
12
Regional demand curve
10
8
6
Consumer
surplus
P=4
$32 million
Blue shaded area shows
consumer surplus accruing
to all consumers in the
market for daycare services
if P =$ 4 per hr.
2
Q
0
2
4
6
8
10 12 14
Hours of Day Care (Millions)
Figure 8.7: A Competitive Daycare Market
Hourly Price
$14
12
Regional daycare demand
10
Equilibrium:
8
P C = $2.50
QC = 9.5 million hours
6
Grandmothers '
day-care
supply
4
$4
'Store-bought " day care
P C = 2.50
2
0
2
4
6
8
Q
14
10 12
9.5
Hours of Day Care (Millions)