Transcript Ch8

chapter
eight
Firms in Perfectly Competitive Markets
Prepared by: Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien
Perfect Competition in the Market for Organic Apples
1
The process of
competition is at the
heart of the market
system and is the
focus of this chapter.
LEARNING OBJECTIVES
CHAPTER 8: Firms in Perfectly
Competitive Markets
After studying this chapter, you
should be able to:
2
3
4
5
6
Define a perfectly competitive
market, and explain why a
perfect competitor faces a
horizontal demand curve.
Explain how a perfect
competitor decides how much
to produce.
Use graphs to show a firm’s
profit or loss.
Explain why firms may shut
down temporarily.
Explain how entry and exit
ensure that firms earn zero
economic profit in the long run.
Explain how perfect competition
leads to economic efficiency.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
2 of 35
CHAPTER 8: Firms in Perfectly
Competitive Markets
Firms in Perfectly Competitive Markets
8–1
The Four Market Structures
MARKET STRUCTURE
CHARACTERISTIC
PERFECT
COMPETITION
MONOPOLISTIC
COMPETITION
OLIGOPOLY
MONOPOLY
Number of firms
Many
Many
Few
One
Type of product
Identical
Differentiated
Unique
Ease of entry
High
High
Identical or
differentiated
Low
Examples of
industries
• Wheat
• Apples
• Selling DVDs
• Restaurants
• Manufacturing
computers
• Manufacturing
automobiles
• First-class
mail delivery
• Tap water
Entry blocked
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
3 of 35
1 LEARNING OBJECTIVE
CHAPTER 8: Firms in Perfectly
Competitive Markets
Perfectly Competitive Markets
Perfectly competitive market
A market that meets the
conditions of (1) many buyers
and sellers, (2) all firms selling
identical products, (3) no
barriers to new firms entering
the market.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
4 of 35
Perfectly Competitive Markets
CHAPTER 8: Firms in Perfectly
Competitive Markets
A Perfectly Competitive Firm Cannot Affect the Market Price
Price taker A buyer or seller that is
unable to affect the market price.
8-1
A Perfectly Competitive Firm
Faces a Horizontal Demand
Curve
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
5 of 35
2 LEARNING OBJECTIVE
How a Firm Maximizes Profit in a
Perfectly Competitive Market
CHAPTER 8: Firms in Perfectly
Competitive Markets
Profit Total revenue minus total cost.
Profit = TR - TC
8-2
The Market Demand for Wheat
versus the Demand or One
Farmer’s Wheat
Don’t Confuse the Demand Curve for Farmer Whaples’s Wheat with the Market Demand Curve for Wheat
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
6 of 35
How a Firm Maximizes Profit in a
Perfectly Competitive Market
CHAPTER 8: Firms in Perfectly
Competitive Markets
Revenue for a Firm in a Perfectly Competitive Market
Average revenue (AR) Total revenue divided by the
number of units sold.
AR 
TR
Q
so, AR 
TR P  Q

P
Q
Q
Marginal revenue (MR) Change in total revenue from
selling one more unit.
Marginal Revenue 
Change in total revenue
TR
, or MR 
Change in quantity
Q
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
7 of 35
How a Firm Maximizes Profit in a
Perfectly Competitive Market
CHAPTER 8: Firms in Perfectly
Competitive Markets
Revenue for a Firm in a Perfectly Competitive Market
8–2
Farmer Whaples’s Revenue
from Wheat Farming
NUMBER OF
BUSHELS
(Q)
MARKET PRICE
(PER BUSHEL)
(P)
TOTAL
REVENUE
(TR)
AVERAGE
REVENUE
(AR)
MARGINAL
REVENUE
(MR)
0
1
2
3
4
5
6
7
8
9
10
$4
4
4
4
4
4
4
4
4
4
4
$0
4
8
12
16
20
24
28
32
36
40
$4
4
4
4
4
4
4
4
4
4
$4
4
4
4
4
4
4
4
4
4
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
8 of 35
How a Firm Maximizes Profit in a
Perfectly Competitive Market
CHAPTER 8: Firms in Perfectly
Competitive Markets
Revenue for a Firm in a Perfectly Competitive Market
8 –3
Farmer Whaples’s Profits from
Wheat Farming
QUANTITY
(BUSHELS)
(Q)
TOTAL
REVENUE
(TR)
TOTAL
COSTS
(TC)
PROFIT
(TR-TC)
0
1
2
3
4
5
6
7
8
9
10
$0.00
4.00
8.00
12.00
16.00
20.00
24.00
28.00
32.00
36.00
40.00
$1.00
4.00
6.00
7.50
9.50
12.00
15.00
19.50
25.50
32.50
40.50
-$1.00
0.00
2.00
4.50
6.50
8.00
9.00
8.50
6.50
3.50
-0.50
MARGINAL
REVENUE
(MR)
MARGINAL
COST
(MC)
$4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
$3.00
2.00
1.50
2.00
2.50
3.00
4.50
6.00
7.00
8.00
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
9 of 35
How a Firm Maximizes Profit in a
Perfectly Competitive Market
CHAPTER 8: Firms in Perfectly
Competitive Markets
Revenue for a Firm in a Perfectly Competitive Market
8-3
The Profit-Maximizing Level
of Output
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 10 of 35
CHAPTER 8: Firms in Perfectly
Competitive Markets
3 LEARNING OBJECTIVE
Illustrating Profit or Loss
on the Cost Curve Graph
Profit = (P x Q)  TC
( P  Q ) TC
Profit


Q
Q
Q
Or
Profit
 P  ATC,
Q
Profit = (P  ATC)Q
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 11 of 35
Illustrating Profit or Loss
on the Cost Curve Graph
CHAPTER 8: Firms in Perfectly
Competitive Markets
Showing a Profit on the Graph
8-4
The Area of Maximum Profit
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 12 of 35
8-1
3 LEARNING OBJECTIVE
CHAPTER 8: Firms in Perfectly
Competitive Markets
Determining Profit-Maximizing Price and Quantity
OUTPUT
PER DAY
TOTAL
COST
MARGINAL
COST
0
1
2
3
4
5
6
7
8
9
$1.00
1.50
1.75
2.25
3.00
4.00
5.25
6.75
8.50
10.50
$0.50
0.25
0.50
0.75
1.00
1.25
1.50
1.75
2.00
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 13 of 35
Illustrating Profit or Loss
on the Cost Curve Graph
CHAPTER 8: Firms in Perfectly
Competitive Markets
Illustrating When a Firm Is Breaking Even or Operating at a Loss
 P > ATC, which means the firm makes a profit
 P = ATC, which means the firm breaks even (its total cost equals it total revenue)
 P < ATC, which means the firm experiences losses
8-5
A Firm Breaking Even and Experiencing Losses
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 14 of 35
CHAPTER 8: Firms in Perfectly
Competitive Markets
Illustrating Profit or Loss
on the Cost Curve Graph
Remember that Firms Maximize Total Profit, Not Profit per Unit
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 15 of 35
8-1
CHAPTER 8: Firms in Perfectly
Competitive Markets
Losing Money in the Medical Screening
Industry
Providing preventive
medical scans turned
out not to be a
profitable business.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 16 of 35
CHAPTER 8: Firms in Perfectly
Competitive Markets
4 LEARNING OBJECTIVE
Deciding Whether to Produce or
to Shut Down in the Short Run
In the short run a firm suffering losses has
two choices:
 Continue to produce
 Stop production by shutting down
temporarily
Sunk cost A cost that has already been
paid and that cannot be recovered.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 17 of 35
8-2
CHAPTER 8: Firms in Perfectly
Competitive Markets
When to Close a Laundry
Keeping a business open even
when suffering losses can
sometimes be the best decision
in the short run.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 18 of 35
Deciding Whether to Produce
or to Shut Down in the Short Run
The Supply Curve of the Firm in the Short Run
CHAPTER 8: Firms in Perfectly
Competitive Markets
8-6
The Firm’s Short-Run Supply Curve
Shutdown point The minimum point on a firm’s average variable cost
curve; if the price falls below this point, the firm shuts down production in
the short run.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 19 of 35
5 LEARNING OBJECTIVE
“If Everyone Can Do It, You Can’t Make Money At
It” – The Entry and Exit of Firms in the Long Run
CHAPTER 8: Firms in Perfectly
Competitive Markets
Economic Profit and the Entry or Exit Decision
8-7
Firm Supply and Market Supply
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 20 of 35
“If Everyone Can Do It, You Can’t Make Money At It” –
The Entry and Exit of Firms in the Long Run
CHAPTER 8: Firms in Perfectly
Competitive Markets
Economic Profit and the Entry or Exit Decision
Economic profit A firm’s revenues
minus all its costs, implicit and
explicit.
Economic loss The situation in
which a firm’s total revenue is less than
its total cost, including all implicit
costs.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 21 of 35
“If Everyone Can Do It, You Can’t Make Money At It” –
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
CHAPTER 8: Firms in Perfectly
Competitive Markets
ECONOMIC PROFIT LEADS TO ENTRY OF NEW FIRMS
8-8
The Effect of Entry on Economic Profits
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 22 of 35
“If Everyone Can Do It, You Can’t Make Money At It” –
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
CHAPTER 8: Firms in Perfectly
Competitive Markets
ECONOMIC LOSSES LEAD TO EXIT OF FIRMS
8-9
The Effect of Exit on Economic Losses
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 23 of 35
“If Everyone Can Do It, You Can’t Make Money At It” –
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
CHAPTER 8: Firms in Perfectly
Competitive Markets
ECONOMIC LOSSES LEAD TO EXIT OF FIRMS
8-9
The Effect of Exit on Economic Losses (cont’d.)
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 24 of 35
“If Everyone Can Do It, You Can’t Make Money At It” –
The Entry and Exit of Firms in the Long Run
CHAPTER 8: Firms in Perfectly
Competitive Markets
Long-Run Equilibrium in a Perfectly Competitive Market
Long-run competitive equilibrium
The situation in which the entry and
exit of firms have resulted in the typical
firm just breaking even.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 25 of 35
CHAPTER 8: Firms in Perfectly
Competitive Markets
“If Everyone Can Do It, You Can’t Make Money At It” –
The Entry and Exit of Firms in the Long Run
The Long-Run Supply Curve in a Perfectly Competitive
Market
Long-run supply curve A curve
showing the relationship in the long
run between market price and the
quantity supplied.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 26 of 35
“If Everyone Can Do It, You Can’t Make Money At It” –
The Entry and Exit of Firms in the Long Run
CHAPTER 8: Firms in Perfectly
Competitive Markets
The Long-Run Supply Curve in a Perfectly Competitive
Market
8 -10
The Long-Run Supply Curve in a Perfectly Competitive Industry
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 27 of 35
6 LEARNING OBJECTIVE
CHAPTER 8: Firms in Perfectly
Competitive Markets
Perfect Competition and Efficiency
Productive Efficiency
Productive efficiency The situation
in which a good or service is produced
at the lowest possible cost.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 28 of 35
8-2
6 LEARNING OBJECTIVE
CHAPTER 8: Firms in Perfectly
Competitive Markets
How Productive Efficiency Benefits Consumers
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 29 of 35
Perfect Competition and Efficiency
CHAPTER 8: Firms in Perfectly
Competitive Markets
Allocative Efficiency
Firms will supply all those goods that provide
consumers with a marginal benefit at least as great as
the marginal cost of producing them:
 The price of a good represents the marginal benefit
consumers receive from consuming the last unit of the
good sold.
 Perfectly competitive firms produce up to the point where
the price of the good equals the marginal cost of
producing the last unit.
 Therefore, firms produce up to the point where the last
unit provides a marginal benefit to consumers equal to
the marginal cost of producing it.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 30 of 35
Perfect Competition and Efficiency
CHAPTER 8: Firms in Perfectly
Competitive Markets
Allocative Efficiency
Allocative efficiency A state of the economy
in which production reflects consumer
preferences; in particular, every good or service is
produced up to the point where the last unit
provides a marginal benefit to consumers equal to
the marginal cost of producing it.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 31 of 35
CHAPTER 8: Firms in Perfectly
Competitive Markets
Organic Food Trend Chips Out a Niche in Snack Food Isle
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 32 of 35
CHAPTER 8: Firms in Perfectly
Competitive Markets
Allocative efficiency
Average revenue (AR)
Economic loss
Economic profit
Long-run supply curve
Marginal revenue
Perfectly competitive
market
Price taker
Productive efficiency
Profit
Shutdown point
Sunk cost
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 33 of 35