Transcript Chpt 7 PP

Perfect Competition
Economics for Today by Irvin Tucker, 6th edition
©2009 South-Western College Publishing
1
What will I learn
in this chapter?
This chapter discusses how
competitive markets determine
prices, output, and profits
2
What economic puzzles
will I learn to solve?
• Why is the demand curve
horizontal for a firm in a
perfectly competitive market?
• Why would a firm stay in
business while losing money?
• In the short run, can alligator
farms earn an economic profit?
3
Who was Adam Smith?
The father of modern
economics who wrote
The Wealth of Nations,
published in 1776
4
What did Adam
Smith say about
competitive forces?
They are like an “invisible
hand” that leads people
who pursue their own
interests to serve the
interests of society
5
What is
market structure?
A classification system for
the key traits of a market,
including the number of
firms, the similarity of the
products they sell, and the
ease of entry and exit
6
What is
perfect competition?
1. many small firms
2. homogeneous product
3. very easy entry and exit
4. price taker
7
What is meant by a
large number of firms?
A large number of sellers
condition is met when
each firm is so small
relative to the total market
that no single firm can
influence the market price
8
What does
homogeneous mean?
Goods that cannot be
distinguished from one
another; for example,
one potato cannot be
distinguished from
another potato
9
What conclusion
can we make?
If a product is
homogeneous,
buyers are indifferent
as to which seller’s
product they buy
10
What does easy
entry mean?
Perfect competition
requires that resources
be completely mobile
to freely enter a market
11
What is a price taker?
A seller that has no
control over the price
of the product
12
What determines price?
Supply and Demand
13
P
$140
$130
Market Supply and Demand
S
$120
$100
$80
$60
$40
D
$20
Q
5 10 15 20 25 30 35 40 45
14
What determines the
individual firm’s
demand curve?
A horizontal line at
the market price
15
$140
$130
$120
$100
Individual firm demand
D
$80
$60
$40
$20
5 10 15 20 25 30 35 40 45
16
Why is this horizontal
line the firm’s
demand curve?
If the firm charges more
than this price, it will not
sell anything, and it has
no incentive to charge
less than this price
17
Why does the firm
have no incentive to
charge less than the
market price?
It can sell everything
it brings to market
at the market price
18
What does the
perfectly competitive
firm control?
The only thing it
controls is how many
units it produces
19
How many units should
this firm produce?
The number of units
whereby it will maximize
its profits, or at least
minimize its losses
20
What are the two
methods to
determine how many
units to produce?
• TR and TC
• MR and MC
21
Using the total
revenue - total cost
method, where should
a firm produce?
Where the distance
between TR and
TC is the greatest
22
P
TR
TC
$500
Maximize Profit
$400
$300
$200
Loss
$100
Quantity of Output
1
2
3
4
5
Q
23
P
$150
TR
$100
$50
0
-$50
1
2
3
4
5
Q
24
What is
marginal revenue?
MR = TR / 1 output
25
What is
marginal cost?
MC = TC / 1 output
26
Using the marginal
revenue and marginal
cost method, where
should a firm produce?
MR = MC
27
Why should a firm
continue to produce
as long as MR > MC?
As long as MR is > than
MC, money is being
made on that last unit
28
Why will a firm not
produce that unit
where MR < MC?
At the unit of output where
MR < MC, money is
being lost on that last unit
29
Why does P = AR in
perfect competition?
Each additional unit sold
is adding the market
price to TR and TR
divided by P = AR
30
Why does P = MR in
perfect competition?
Because each unit sells for
the same price, therefore
each unit sold adds the
price to total revenue
31
What conclusion
can we make?
Price equals marginal
revenue equals average
revenue equals the firm’s
short run demand curve
32
Why is the firm’s
demand curve horizontal
at the market price?
Because the firm can
sell all it produces at
the market price
33
$60
$50
$40
$30
$20
$10
Price & Cost per unit
$80
$70
1
MC ATC
P = MR = AR
MR=MC
D
Profit
AVC
2
3
4
5
6
7
8
9
34
$70
$60
$50
$40
$30
$20
$10
Price & Cost per unit
P
1
MR=MC
MC
ATC
AVC
Loss
2
3
P=MR=AR
4
5
6
7
8
9
D
Q
35
$70
$60
$50
$40
$30
$20
$10
Shutdown Point
Price & Cost per unit
P
1
MC
ATC
AVC
Loss
P=MR=AR
D
MR=MC
2
3
4
5
6
7
8
9
Q
36
Firm will shut down
Price (MR) is below
minimum average
variable cost
37
What is the perfectly
competitive firm’s shortrun supply curve?
The firm’s marginal cost
curve above the minimum
point on its average
variable cost curve
38
P
Firm’s Short-Run Supply Curve
MC
$70
$60
$50
$40
$30
$20
ATC
MR3
AVC
MR2
MR1
$10
1 2
3
4
5
6
7
8
9
Q
39
What is the industry’s
supply curve?
The summation of the
individual firm’s MC
curves that lie above their
minimum AVC points
40
P
$130
$120
$100
$80
$60
$40
Industry Equilibrium
S = MC
D
$20
Q
5 10 15 20 25 30 35 40 45
41
What is a normal profit?
The minimum profit
necessary to keep
a firm in operation
42
In the long-run,
what happens when
economic profits
are made?
When firms make more
than a normal profit, firms
enter the industry, as
supply increases, a
downward pressure is
put on prices
43
In the long-run, what
happens when
losses are made?
When firms make less than
a normal profit, firms leave
the industry, as supply
decreases, an upward
pressure is put on prices
44
In the long-run, where
is equilibrium?
At the market price
that enables firms to
make a normal profit
45
What exists at long-run
perfectly competitive
equilibrium?
P = MR = SRMC =
SRATC = LRAC
46
P
$70
$60
$50
$40
$30
$20
Long-Run Competitive Equilibrium
Equilibrium
SRMC
SATC
LRAC
MR
$10
1
2
3
4
5
6
7
8
9
Q
47
END
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