Transcript Chapter 24 - The Citadel

Chapter 24
Perfect
Competition
Introduction
A relatively new health care product offered
for sale is the full-body CT scan.
There are many firms offering this service,
and yet they all charge nearly identical prices.
Why would such a personal service not vary
in price much between different providers?
Slide 24-2
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
Slide 24-3
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
Slide 24-4
Chapter Outline
 Characteristics of a Perfectly
Competitive Market Structure
 The Demand Curve of the Perfect
Competitor
 How Much Should the Perfect
Competitor Produce?
Slide 24-5
Chapter Outline
 Using Marginal Analysis to Determine the
Profit-Maximizing Rate of Production
 Short-Run Profits
 The Short-Run Shutdown Price
 The Perfect Competitor’s Short-Run Supply
Curve
Slide 24-6
Chapter Outline
 Competitive Price Determination
 The Long-Run Industry Situation: Exit and
Entry
 Long-Run Equilibrium
 Competitive Pricing: Marginal Cost Pricing
Slide 24-7
Did You Know That...
 Clothing retailers commonly cite bad
weather as the reason for poor profit
performance?
 The competitive nature of this market
best explains why profits are kept to a
modest level?
Slide 24-8
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
Slide 24-9
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
Slide 24-10
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
Slide 24-11
International Example:
How Free Entry Can Shift Resources
 In 1981, Chile began offering a
program of school choice.
 If parents decided to enroll their
children in a private school, public
funds would be made available to that
school to cover all or part of tuition.
Slide 24-12
International Example:
How Free Entry Can Shift Resources
 Such a program reorders the
incentives both for parents and
schools.
 Since inception of the program, more
than 1,200 new private schools have
been formed.
Slide 24-13
Characteristics of a Perfectly
Competitive Market Structure
 Price taker:
– A firm can sell as much as wants at the
going market price.
– There is no incentive to sell for a lower
price.
– Attempts to charge a higher price will
result in no sales.
Slide 24-14
Characteristics of a Perfectly
Competitive Market Structure
 Characteristics of perfect competition
– Large number of buyers and sellers
– Homogenous products
• When you buy a head of lettuce do you ask
what farm it came from?
– No barriers to entry or exit
– Buyers and sellers have equal access to
information
Slide 24-15
The Demand Curve
of the Perfect Competitor
 Question
– If the perfectly competitive firm is a price
taker, who or what sets the price?
Slide 24-16
The Demand Curve
for Recordable DVDs
Neither an individual
buyer nor seller can
influence the price
Price per DVD
S
The interaction of market
supply and demand yields
an equilibrium price of $5
and quantity of 30,000 units
E
5
D
0
Figure 24-1, Panel (a)
10,000 20,000 30,000 40,000 50,000
DVDs per Day
Slide 24-17
The Demand Curve
of the Perfect Competitor
 The perfectly competitive firm:
– Is a price taker (i.e., must sell for $5)
– Will sell all units for $5
– Will not be able to sell at a higher price
– Will not choose to sell more units at a
lower price
Slide 24-18
The Demand Curve Facing the
Perfectly Competitive Firm
Figure 24-1, Panels (a) and (b)
Slide 24-19
How Much Should
the Perfect Competitor Produce?
 The firm will produce the level of output
that will maximize profits given the
market price.
Economic
= total revenue (TR) - total cost (TC)
 Totalprofit
Revenues
– The price per unit times the total quantity
sold
Slide 24-20
How Much Should
the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TR = P x Q
P determined by the market in perfect competition
Q determined by the producer to maximize profit
Slide 24-21
How Much Should
the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TC  explicit + opportunity cost
Slide 24-22
Profit Maximization
Figure 24-2, Panel (a)
Slide 24-23
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
Figure 24-2, Panel (b)
Slide 24-24
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
– Also, the rate of production at which
marginal revenue equals marginal cost
Slide 24-25
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
$5
3
5
2
5
1
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
Figure 24-2, Panel (c)
Slide 24-26
Using Marginal Analysis to Determine
the Profit-Maximizing Rate of Production
 Marginal revenue is the change in total
revenue divided by the change in
output
 Marginal cost is the change in total
cost divided by the change in output
Slide 24-27
Using Marginal Analysis to Determine
the Profit-Maximizing Rate of Production
 Profit maximization
– Economic profits = TR  TC
– Profit-maximizing output occurs when
MC = MR
– For a perfectly competitive firm, this is
at the intersection of the firm’s demand
schedule and its marginal cost curve
Slide 24-28
Short-Run Profits
 To find out what our competitive
individual DVD producer is making in
terms of profits in the short run, we
have to determine the excess of price
above average total cost
Slide 24-29
Short-Run Profits
14
Price and Cost per Unit ($)
13
12
11
10
• Recall: Profits are
maximized at 7.5 units
where MC = MR.
• How do we measure
profits?
9
8
7
6
5
4
3
2
1
0
1
2
3
4
5
6
7
8
DVDs per Day
9 10 11 12
Slide 24-30
Short-Run Profits
14
Price and Cost per Unit ($)
13
12
11
MC
10
• Profit is maximized where
MR = MC
• ATC = TC/output
• TC = ATC  output
• TR = P  output
• Profit = (P - ATC)  output
9
8
7
ATC
Profits
6
d
5
P = MR = AR
4
3
2
1
0
Figure 24-3
1
2
3
4
5
6
7
8
DVDs per Day
9 10 11 12
Slide 24-31
Minimization of Short-Run Losses
14
• Losses are minimized
where MR = MC
• Loss = ($3 - 4.35)  5.5 or
$7.43
Price and Cost per Unit ($)
13
12
11
MC
10
9
8
7
6
ATC
Losses
d1
5
4
d2
3
P = MR = AR
2
1
0
Figure 24-4
1
2
3
4
5
6
7
8
DVDs per Day
9 10 11 12
Slide 24-32
Short-Run Profits
 Short-run average profits or average
losses are determined by comparing
average total costs with price (average
revenue) at the profit-maximizing rate
of output.
 In the short run, the perfectly
competitive firm can make economic
profits or economic losses.
Slide 24-33
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?
Slide 24-34
Short-Run Shutdown
and Break-Even Price
Figure 24-5
Slide 24-35
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?
Slide 24-36
The Short-Run Shutdown Price
 As long as the price per unit sold
exceeds the average variable cost per
unit produced, the firm will be covering
at least part of the opportunity cost of
the investment in the business—that is,
part of its fixed costs.
Slide 24-37
The Short-Run Shutdown Price
 Short-Run Break-Even Price
– The price at which a firm’s total revenues equal
its costs
– At the break-even price, the firm is just making a
normal rate of return on its capital investment
 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
Slide 24-38
The Meaning
of Zero Economic Profits
 Why produce if you are not making a
profit?
 Hint:
– Distinguish between economic profits and
accounting profits
– When economic profits are zero,
accounting profits are positive
Slide 24-39
The Perfect Competitor’s
Short-Run Supply Curve
 Question
– What does the supply curve for the individual firm
look like?
 Answer
– The firm’s supply curve is the marginal cost curve
above the short-run shutdown point.
– Thus, the competitive firm’s short-run supply
curve is its marginal costs curve equal to and
above the point of intersection with the average
variable cost curve.
Slide 24-40
The Individual Firm’s
Short-Run Supply Curve
• Given the price, the quantity is
determined where MC = MR
• Short-run supply = MC above
minimum AVC
Figure 24-6
Slide 24-41
The Perfect Competitor’s
Short-Run Supply Curve
 The Industry Supply Curve
– The locus of points showing the minimum
prices at which given quantities will be
forthcoming
Slide 24-42
Deriving the Industry Supply Curve
P2
P1
q A1 q A2
Quantity per Time Period
Panel (c)
MCB
P2
P1
q B1
q B2
Quantity per Time Period
Figure 24-7, Panels (a), (b), and (c)
Price and Marginal Cost per Unit
MCA
Panel (b)
Price and Marginal Cost per Unit
Price and Marginal Cost per Unit
Panel (a)
S = ΣMC
G
P2
P1
F
(q A1 + q B1) (q A2 + q B2)
Quantity per Time Period
Slide 24-43
The Perfect Competitor’s
Short-Run Supply Curve
 Factors that influence the industry
supply curve (determinants of supply)
– Firm’s productivity
– Factor costs
– Taxes and subsidies
– Number of firms
Slide 24-44
Competitive Price Determination
 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.
Slide 24-45
Competitive Price Determination
 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
Slide 24-46
Competitive Price Determination
Pe is the price
the firm must take
Pe and Qe determined
by the interaction of
the industry S and
market D
Figure 24-8, Panel (a)
Slide 24-47
Competitive Price Determination
Given Pe, firm produces qe where MC = MR
-If AC = AC1, break-even
-If AC = AC2, losses
-If AC = AC3, economic profit
Figure 24-8, Panel (b)
Slide 24-48
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.
Slide 24-49
The Long-Run Industry Situation:
Exit and Entry
 Signals
– Compact ways of conveying to economic
decision makers information needed to
make decisions
– A true signal not only conveys information
but also provides the incentive to react
appropriately
Slide 24-50
The Long-Run Industry Situation:
Exit and Entry
 Summary
– Economic profits
• Signal resources to enter the market and the
price falls to the break-even price
– Economic losses
• Signal resources to exit the market and the
price increases to the break-even level
Slide 24-51
The Long-Run Industry Situation:
Exit and Entry
 Summary
– At break-even
• Resources will not enter or exit because the
market is yielding a normal rate of return
– In the long run, the perfectly competitive
firm will make zero economic profits (a
normal rate of return)
Slide 24-52
The Long-Run Industry Situation:
Exit and Entry
 Long-Run Industry Supply Curve
– A market supply curve showing the
relationship between price and quantities
forthcoming after firms have been allowed
time to enter or exit from an industry
Slide 24-53
The Long-Run Industry Situation:
Exit and Entry
 Constant-Cost Industry
– An industry whose total output can be
increased without an increase in long-run
per-unit costs
Slide 24-54
Constant-Cost Industry
Panel (a)
Constant Cost
Price per Unit
S1
S2
E2
P2
P1
SL
E1
E3
D1
D2
Quantity per Time Period
Figure 24-9, Panel (a)
Slide 24-55
The Long-Run Industry Situation:
Exit and Entry
 Increasing-Cost Industry
– An industry in which an increase in
industry output is accompanied by an
increase in long-run per unit costs
Slide 24-56
Increasing-Cost Industry
Panel (b)
Increasing Cost
S1
Price per Unit
S2
SL'
P2
P1
D2
D1
Quantity per Time Period
Figure 24-9, Panel (b)
Slide 24-57
The Long-Run Industry Situation:
Exit and Entry
 Decreasing-Cost Industry
– An industry in which an increase in
industry output leads to a reduction in
long-run per-unit costs
Slide 24-58
Decreasing-Cost Industry
Price per Unit
Panel (c)
Decreasing Cost
S1
S2
P1
P2
SL''
D1
D2
Quantity per Time Period
Figure 24-9, Panel (c)
Slide 24-59
Example:
The Market for Transistors
 Since the late 1960’s, the annual production
of transistors has expanded from 1 billion to
1 quintillion.
 At the same time, the cost per unit has
dropped from about $1 to a miniscule
fraction of a penny.
 Transistor production serves as a good
illustration of a decreasing-cost industry.
Slide 24-60
Long-Run Equilibrium
 Firms will adjust plant size until there is no
further incentive to change.
 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.
Slide 24-61
Long-Run Firm
Competitive Equilibrium
LAC
Price per Unit
MC
P
SAC
E
d = MR = P = AR
Qe
Units per Year
Figure 24-11
Slide 24-62
Competitive Pricing:
Marginal Cost Pricing
 Marginal Cost Pricing
– A system of pricing in which the price
charged is equal to the opportunity cost to
society of producing one more unit of the
good or service in question
Slide 24-63
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
Slide 24-64
Issues and Applications:
Full-Body Medical Scanning
 Full-body CT scans can provide early
detection of internal diseases.
 In the late 1990’s, the price of the
procedure was about $1,500.
 This price was well above the
provider’s average cost.
Slide 24-65
Issues and Applications:
Full-Body Medical Scanning
 More firms entered the market of providing
CT scans in response to the profit level.
 In recent years, some physicians have
recommended against the procedure.
 The simultaneous increase in supply and
decrease in demand has dropped the
prevailing price to about $400, which allows
the remaining firms to earn a normal profit.
Slide 24-66
Summary Discussion
of Learning Objectives
 The characteristics of a perfectly
competitive market structure
– Large number of buyers and sellers
– Homogeneous product
– No barriers to entry and exit
– Buyers and sellers have equal access to
information
Slide 24-67
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
above minimum average variable cost
Slide 24-68
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
Slide 24-69
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
Slide 24-70
Summary Discussion
of Learning Objectives
 The long-run industry supply curve and
constant-, increasing-, and decreasing-cost
industries
– The relationship between price and quantity after
firms have been able to enter or exit the industry
– Constant-cost industry
• Horizontal long-run supply curve
– Increasing-cost industry
• Upward-sloping long-run supply curve
– Decreasing-cost industry
• Downward-sloping long-run supply curve
Slide 24-71
End of
Chapter 24
Perfect
Competition