Transcript Chapter24 - QC Economics

Chapter 24
Perfect Competition
Learning Objectives
 Identify the characteristics of a perfectly
competitive market structure
 Discuss the process by which a perfectly
competitive firm decides how much output to
produce
 Understand how the short-run supply curve for a
perfectly competitive firm is determined
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Learning Objectives
 Explain how the equilibrium price is determined
in a perfectly competitive market
 Describe what factors induce firms to enter or exit
a perfectly competitive industry
 Distinguish among constant-, increasing-, and
decreasing-cost industries based on the shape of
the long-run industry supply curve
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Did You Know That...
Under extreme perfectly competitive
situations, individual buyers and sellers
cannot affect the market price?
Economic profits that perfectly competitive
firms may earn for a time ultimately
disappear as other firms enter the industry?
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Characteristics of a Perfectly
Competitive Market Structure
Perfect Competition
– A market structure in which the decisions of
individual buyers and sellers have no effect on
market price
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Characteristics of a Perfectly
Competitive Market Structure
Perfectly Competitive Firm
– A firm that is such a small part of the total
industry that it cannot affect the price
of the product or service that it sells
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Characteristics of a Perfectly
Competitive Market Structure
Price Taker
– A competitive firm that must take the price of
its product as given because the firm cannot
influence its price (Perfect Competitors are
price takers and Monopolists are price
searchers)
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Characteristics of a Perfectly
Competitive Market Structure
Why a perfect competitor is a
price taker
1. Large number of buyers and sellers
2. Homogenous products are perfect substitutes
3. Buyers and sellers have equal access
to information
4. No barriers to entry or exit
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The Demand Curve of the
Perfect Competitor
Question
– If the perfectly competitive firm is a price taker,
who or what sets the price?
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The Demand Curve for a Producer of
Flash Memory Pen Drives
Neither an individual
buyer nor seller can
influence the price
The interaction of market
supply and demand yields
an equilibrium price of $5
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The Demand Curve of the
Perfect Competitor
The perfectly competitive firm is a price
taker, selling a homogenous commodity
with perfect substitutes.
– Will sell all units for $5
– Will not be able to sell at a higher price
– Will face a perfectly elastic demand curve at
the going market price
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The Demand Curve for a Producer of
Flash Memory Pen Drives
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How Much Should the Perfect
Competitor Produce?
Perfect competitor accepts price
as given
– Firm raises price, it sells nothing
– Firm lowers its price, it earns less revenues than
it otherwise would
Perfect competitor has to decide how much
to produce
– Firm uses profit-maximization model
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How Much Should the Perfect
Competitor Produce?
 The model assumes that firms attempt to
maximize their total profits.
– The positive difference between total revenues and total
costs
 The model also assumes firms seek to minimize
losses.
– When total revenues may be less than total costs
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How Much Should the Perfect
Competitor Produce?
Total Revenues
– The price per unit times the total quantity sold
– The same as total receipts from the sale of
output
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How Much Should the Perfect
Competitor Produce?
Profit = Total revenue (TR) – Total cost (TC)
TR = P x Q
TC = TFC + TVC
P determined by the market in perfect competition
Q determined by the producer to maximize profit
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Profit Maximization
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Profit Maximization
Total
Output/
Sales/ Total
day
Costs
Market
Price
Total
Revenue
Total
Profit
0
$10
$5
$0
$10
1
15
5
5
10
2
18
5
10
8
3
20
5
15
5
4
21
5
20
1
5
23
5
25
2
6
26
5
30
4
7
30
5
35
5
8
35
5
40
5
9
41
5
45
4
10
48
5
50
2
11
56
5
55
1
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How Much Should the Perfect
Competitor Produce?
Profit-Maximizing Rate of Production
– The rate of production that maximizes total
profits, or the difference between total revenues
and total costs
– The rate of production at which marginal
revenue equals marginal cost
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Profit Maximization
Total
Output/
Sales/ Market
day
Price
0
$5
1
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
9
5
10
5
11
5
Marginal
Cost
Marginal
Revenue
$5
$5
3
5
2
5
1
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
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Using Marginal Analysis to Determine
the Profit-Maximizing Rate of Production
Marginal Revenue
– The change in total revenues divided by the
change in output
Marginal Cost
– The change in total cost divided by the change
in output
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Using Marginal Analysis to
Determine the Profit-Maximizing
Rate of Production
Profit maximization occurs at the rate of
output at which marginal revenue equals
marginal cost.
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Short-Run Profits
To find out what our competitive individual
flash memory producer is making in terms
of profits in the short run, we have to
determine the excess of price above average
total cost.
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Short-Run Profits
From Figure 24-2 previously, if we
have production and sales of seven flash
drives, TR = $35, TC = $30, and profit =
$5.
Now we take info from column 6 in panel
(a) and add it to panel (c) to get Figure 24-3.
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Measuring Total Profits
• Profits are maximized where
MR = MC
• This occurs at Q = 7.5 units
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Short-Run Profits
Graphical depiction of maximum profits
– The height of the rectangular box represents
profits per unit.
– The length represents the amount of
units produced.
– When we multiply these two quantities, we get
total economic profits.
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Minimization of Short-Run
Losses
• Losses are minimized where
MR = MC
• This occurs at Q = 5.5 units
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Short-Run Profits
Short-run average profits are determined by
comparing ATC with P = MR = AR at the
profit-maximizing Q.
In the short run, the perfectly competitive
firm can make either economic profits or
economic losses.
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The Short-Run Shutdown Price
What do you think?
– Would you continue to produce if you were
incurring a loss?
• In the short run?
• In the long run?
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The Short-Run Shutdown Price
 As long as the loss from staying in
business is less than the loss from shutting
down, the firm will continue to produce.
 A firm goes out of business when the
owners sell its assets; a firm temporarily
shuts down when it stops producing, but is
still in business.
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The Short-Run Shutdown Price
As long as the price per unit sold exceeds
the average variable cost per unit
produced, the earnings of the firm’s
owners will be higher if it continues to
produce in the short run than if it shuts
down.
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The Short-Run Shutdown Price
 Short-Run Break-Even Price
– The price at which a firm’s total revenues equal its total
costs
– At the break-even price, the firm is just making a
normal rate of return on its capital investment (it’s
covering its explicit and implicit costs).
 Short-Run Shutdown Price
– The price that just covers average variable costs
– It occurs just below the intersection of the marginal cost
curve and the average variable cost curve.
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Short-Run Shutdown and BreakEven Prices
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The Meaning of Zero Economic Profits
Question
– Why produce if you are not making a profit?
Answer
– Distinguish between economic profits and
accounting profits.
– Remember when economic profits are zero a
firm can still have positive accounting profits.
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The Supply Curve for a
Perfectly Competitive Industry
Question
– What does the short-run supply curve for the
individual firm look like?
Answer
– The firm’s short-run supply curve is its
marginal cost curve at and above the point of
intersection with the average variable cost
curve.
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The Individual Firm’s ShortRun Supply Curve
• Given the price, the
quantity is determined
where MC = MR
• Short-run supply = MC
above minimum AVC
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The Supply Curve for a
Perfectly Competitive Industry
The Industry Supply Curve
– The locus of points showing the minimum
prices at which given quantities will be
forthcoming
– Also called the market supply curve
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Deriving the Industry Supply
Curve
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The Supply Curve for a
Perfectly Competitive Industry
Factors that influence the industry supply
curve (determinants of supply)
– Firm’s productivity
– Factor costs
• Wages, prices of raw materials
– Taxes and subsidies
– Number of sellers
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Price Determination Under
Perfect Competition
Question
– How is the market, or “going,” price
established in a competitive market?
Answer
– This price is established by the
interaction of all the suppliers (firms)
and all the demanders.
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Price Determination Under
Perfect Competition
The competitive price is determined by the
intersection of the market demand curve
and the market supply curve.
– The market supply curve is equal to the
horizontal summation of the supply curves of
the individual firms.
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Industry Demand and Supply Curves
and the Individual Firm Demand Curve
Pe is the price
the firm must take
Pe and Qe determined by
the interaction of the
industry S and market D
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Industry Demand and Supply Curves
and the Individual Firm Demand Curve
• Given Pe, firm produces qe where MC = MR
 If AC = AC1, break-even
• If AC = AC2, losses
• If AC = AC3, economic profit
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The Long-Run Industry
Situation: Exit and Entry
Profits and losses act as signals for
resources to enter an industry or to leave an
industry.
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The Long-Run Industry
Situation: Exit and Entry
Signals
– Compact ways of conveying to economic
decision makers information needed to make
decisions
– An effective signal not only conveys
information but also provides the incentive to
react appropriately.
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The Long-Run Industry
Situation: Exit and Entry
Exit and entry of firms
– Economic profits
• Signal resources to enter the market
– Economic losses
• Signal resources to exit the market
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The Long-Run Industry
Situation: Exit and Entry
Allocation of capital and market signals
– Price system allocates capital according to the
relative expected rates of return on alternative
investments.
– Investors and other suppliers of resources
respond to market signals about their highestvalued opportunities.
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The Long-Run Industry
Situation: Exit and Entry
Tendency toward equilibrium (note that
firms are adjusting all of the time)
– At break-even, resources will not enter or exit
the market.
– In competitive long-run equilibrium, firms will
make zero economic profits.
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The Long-Run Industry
Situation: Exit and Entry
Long-Run Industry Supply Curve
– A market supply curve showing the relationship
between prices and quantities after firms have
been allowed time to enter or exit from an
industry, depending on whether there have been
positive or negative economic profits
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Long-Run Equilibrium
 In the long run, the firm can change the scale of its
plant, adjusting its plant size in such a way that it
has no further incentive to change; it will do so
until profits are maximized.
 In the long run, a competitive firm produces where
price, marginal revenue, marginal cost, short-run
minimum average cost, and long-run minimum
average cost are equal.
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Long-Run Firm Competitive
Equilibrium
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Competitive Pricing:
Marginal Cost Pricing
Market Failure
– A situation in which an unrestrained market
operation leads to either too few
or too many resources going to a specific
economic activity
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Issues and Applications: The Big Rush to
Provide Digital Snaps in a Snap
 The photography industry brings in about
$85 billion in revenues each year.
 Since 2000, the majority of those revenues have
been earned from the sale of digital cameras and
related digital photography products and services.
 During the mid-2000s, a rapidly growing part of
the digital photography business has been the
market for digital photo printing services.
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Issues and Applications: The Big Rush to
Provide Digital Snaps in a Snap
The demand for digital photo printing
services increased, and the market clearing
price rose from 15 to about 19 cents.
Numerous firms entered the industry
causing market supply to increase and the
market clearing price declined from 19
cents to about 12 cents.
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Short-Run and
Long-Run Adjustments in the Digital
Photo Printing Industry
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Summary Discussion
of Learning Objectives
The characteristics of a perfectly
competitive market structure
1. Large number of buyers and sellers
2. Homogeneous product
3. Buyers and sellers have equal access
to information
4. No barriers to entry and exit
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Summary Discussion
of Learning Objectives
How a perfectly competitive firm decides
how much to produce
– Economic profits are maximized when
marginal cost equals marginal revenue as long
as the market price is not below the short-run
shutdown price, where the marginal cost curve
crosses the average variable cost curve.
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Summary Discussion
of Learning Objectives
 The short-run supply curve of a perfectly
competitive firm
– The rising part of the marginal cost curve above
minimum average variable cost
 The equilibrium price in a perfectly competitive
market
– A price at which the total amount of output supplied by
all firms is equal to the total amount of output
demanded by all buyers
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Summary Discussion
of Learning Objectives
Incentives to enter or exit a perfectly
competitive industry
– Economic profits induce entry of new firms.
– Economic losses will induce firms to exit the
industry.
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