Transcript Perfect Competition

Perfect Competition
Completely Unrealistic Yet Entirely
Relevant
Market Structures
In Economics, we identify four basic market
structures.
A market structure reflects three basic
characteristics
Number of firms in the market
Product differentiation
Ease of entry into the market
Four Market Structures
Perfect Competition – many firms selling the same
product
Monopolistic Competition – many firms selling
differentiated products
Oligopoly – few firms selling differentiated (yet
very similar) products
Monopoly – a great board game, ALWAYS buy
the railroads if you can!
HA HA Seriously, that is the LAST “monopoly is a
board game” joke for the year…
In reality, a monopoly is always one firm selling a
unique product.
Perfect Competition
Very many firms
Generally, the firms are very small, could be just one person who works for him or
herself.
Wide selling radius
In perfect competition, the small firm must sell its products in a wide market,
usually nationally or internationally
Standardized products
The product produced by one firm cannot differ in any way from that produced by
another
No need for advertisement or any other forms of non-price competition
Price-Takers
A firm in perfect competition cannot set the price of their product
The market will determine the price, the firm can only choose the quantity sold
Attempts at changing the price by a firm will result in less than the profit
maximized position
Free Entry and Exit
Firms may come and go with no barriers (legal, technological, financial, etc.)
Examples of Perfect Competition
Truthfully, there are not many.
Farming used to be a good example, but today most farms
are owned by large corporations and entry into the market
is very financially difficult for small farmers
Stock Market
Each share of a stock is exactly the same as the next share
Why would the following NOT be perfectly competitive?
Airline Industry
Clothing Industry
Television Broadcasting
Private Education
The Industry and the Firm
An industry is a place where many firms sell their products to many
buyers.
Within the industry, the supply curve reflects all of the supply curves
of all of the firms added together.
Within the industry, the demand curve reflects all of the demand curves
of all of the buyers added together.
The equilibrium point in the industry tells us two things.
First, the price that all firms in the perfectly competitive industry MUST
accept.
Second, the total quantity of the product that will be produced by all of the
firms in the industry.
Since, each firm within a perfectly competitive industry is so small,
they can choose to produce as much or as little as they want
If they were large enough to have a significant market share, the industry
would no longer be perfectly competitive.
The Graph
Price per Bushel
in Chicago
D
A
B
C
Industry
supply
curve
E
$3
$3
S
Industry
demand
curve
Firm’s demand
curve
S
D
0
1
2
3
4
0
100 200 300 400
Truckloads of Corn
Sold by Farmer Jasmine
per Year
Total Sales in Chicago
in Thousands of Truckloads
per Year
(a)
(b)
The Graph – What to Know
The Difference Between the Industry and
Firm
For the firm, Marginal Revenue = Demand =
Average Revenue = Price…or…
Mr. Darp, seen here, is always
horizontal at the market price
Let’s Get the Numbers Down
CENSORED
Profit Maximization – Da Short Run
We know that profit maximization occurs where
MR = MC.
In the case of a perfectly competitive firm, MR =
P, so P = MC at the profit maximized level
At this point, we can determine the quantity that
will be produced by the firm.
What happens to the quantity produced when the
demand in the industry increases?
What happens when the variable costs of
production increase at each level of production?
The Short-Run Profit
In order to determine the profit of the firm, we have to
analyze the revenue and costs.
We know, at the point of profit maximization, what the
average revenue (AR) is. What is it?
It’s the PRICE! (AR = P)
Now, all we need to know is the average cost of each unit
we product (ATC).
Profit = P – ATC since this tells us how much profit will be
made at the profit maximized level.
Exercise:
In the last table, identify the AVERAGE TOTAL COST for each
level of production.
Graph the MR, AR, MC, and AC.
Revenue and Cost per Bushel
Identifying Short-Run Profit
MC
AC
B
$3.00
2.25
1.50
0
D = MR = AR
A
Let’s identify
1. Total Revenue
2. Total Cost
50,000
3. Total Profit
Bushels of Corn per Year
Graphical Analysis
The graph tells us
The total revenue (big box)
The total cost (the bottom portion)
The total profit (the box between the AR (D)
line and the total cost box)
Complete #1 from Activity 34
Sometimes, Mr. Darp aint so nice…
In the instance where MR. DARP is above
ATC, the firm will be making economic
profit (i.e. profit even with opportunity costs
being accounted for).
What might happen, however, if the
industry demand were to fall? Let’s see…
Minimized Short-Run Losses
When the ATC is above AR at the profit maximized point,
the firm is actually going to lose money.
In this instance, their loss is minimized. If they choose to
produce at another level, the loss becomes worse.
In the short-run, the firm will have a decision to make…
Continue to operate in the short-run and lose money or
Shut down and lose money
Rule: In the short run, a firm will continue to operate if
A. Profits are being made
B. Losses are smaller than fixed costs (revenue is above the
average variable cost curve)/
Graphically Speaking
In the short run, a firm will remain open when
MR=D=AR=P is above the ATC curve or
MR=D=AR=P is below the ATC curve but above the
AVC curve
In the short run, a firm will shut-down when
MR=D=AR=P is below the AVC curve
In your notes, draw an example of each.
Note: that in the short-run, the firms supply curve
is its MC curve above the AVC curve.
So, what happens in the long run?
Firms, in the long run, will be able to escape
from fixed costs if they wish to.
Under the condition where a firm is taking
any kind of loss in the short run, the firm
will exit the industry in the long-run…
Under any condition where a firm is making
a profit in the short-run, the firm will
continue to operate...
Exit and Entry
In the long run, firms can exit with no
trouble. Other firms can also enter the
industry with no trouble.
What will cause a firm to leave the industry
in the long-run?
What will cause a firm to enter the industry
in the long-run?
The next step…
Industry Supply
As firms enter and exit the industry, the industry
supply curve is affected.
If there is above zero-economic profit being made
by firms in and industry, more firms will enter the
industry…
If more firms enter the industry, the supply of the
industry will shift to the right…
What will happen to price? What will this do to
the profit maximizing firm that is making profit in
the short-run?
Competition in the Long-Run
Firm
Industry
MC
(1,000 firms)
S0
e
$3.00
2.25
a
D0
D1
b
40 45 50
Price per Bushel
Price per Bushel
AC
D
E
(1,600 firms)
S1
$3.00
A
2.25
S0
D
S1
50
Quantity of Corn in
Thousands of Bushels
Quantity of Corn in
Millions of Bushels
(a)
(b)
72
Long-Run Profit
As more firms enter, those firms making an
economic profit will see their profit shrink…
This process will continue until all firms in the
long-run are making ZERO ECONOMIC
PROFITS.
The long-run condition for firms in perfect
competition is ZERO ECONOMIC PROFITS…
Under this condition, MR=MC=ATC.
The same situation occurs for firms that are taking
losses…
Losses and Zero Economic Profit
If firms are taking losses in the short-run, they will
exit in the long-run….
As firms exit, the industry supply curve shifts to
the left…
What will happen to the industry price?
What will happen for firms taking losses in the
short-run that stay open?
Again, the price will rise until all firms operating
in long-run equilibrium are making ZERO
ECONOMIC PROFIT.
What does this mean?
Fact: In perfect competition, firms will operate
with ZERO-ECONOMIC PROFIT.
Fact: In perfect competition, firms will operate at
maximized efficiency. Firms that survive in the
long-run will produce at the lowest point on their
ATC curve.
Fact: In perfect competition, consumers will pay
the lowest price possible for any given good or
service.
Not Fact: Perfect competition is real and alive and
well…