Transcript Perfect Competition

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Perfect Competition:
Short Run and Long Run
Prepared by:
Fernando Quijano and Yvonn Quijano
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
O’Sullivan/Sheffrin
Perfectly Competitive Market
A perfectly competitive market is a market
with four features:
• There are many firms.
• The product is standardized or
homogeneous.
• Firms can freely enter or leave the market in
the long run.
• Each firm takes the market price as given.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Short-Run Output Decision
The firm’s objective is to maximize its
profit, equal to revenue minus cost.
• Total revenue is the money the firm gets by
selling its product; equal to the price times
the quantity sold.
• Economic profit equals total revenue
minus total economic cost.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Total Approach
• Choose the quantity of output that generates the largest
vertical difference between the total revenue curve and
total cost curve.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Marginal Approach
• choose the quantity at which marginal revenue
equals marginal cost
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Shut-Down Decision
• The firm should continue to operate if the
benefit of operating (total revenue) exceeds
the cost of operating, or total variable cost
• Remember: Variable costs are…
• When the fixed costs are very high, it is
sometimes better to continue operating at a
slight loss, rather then shut-down completely
and have to pay the fixed costs in full
• Why don’t we continue operating when profit
sinks below the variable costs?
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Shut-down Decision
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Short-Run Supply Curves
• The firm’s short-run supply curve
shows the relationship between the
price of a product and the quantity of
output supplied by a firm in the short
run.
• The firm’s short-run supply curve is the
part of the firm’s short-run marginal
cost curve above the shut-down price.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Short-Run Supply
Curve of the Firm
• short-run supply
curve shows the
relationship between
the price of a product
and the quantity of
output supplied (in the
short run)
• = the part of the firm’s
short-run marginal cost
curve above the shutdown price.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Short-Run Market Supply Curve
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
A Market in Long-Run Equilibrium
• A market reaches a long-run equilibrium when three
conditions hold:
1. The quantity of the product supplied equals the quantity
demanded
2. Each firm in the market maximizes its profit, given the
market price
3. Each firm in the market earns zero economic profit, so
there is no incentive for other firms to enter the market
• In addition to the conditions above, in long-run equilibrium
the typical firm earns zero economic profit so there is no
further incentive for firms to enter the market.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
A Market in Long-run Equilibrium
•
In long-run equilibrium, price equals marginal cost
(the profit-maximizing rule), and price equals shortrun average total cost (zero economic profit).
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Production Costs and the Size of the
Industry in the Long Run
Industry Output and Average Production Cost
Number of
Firms
Industry
Output
Rakes
per Firm
Typical Cost for
Typical Firm
Average
Cost per
Rake
50
350
7
$70
$10
100
700
7
84
12
150
1,050
7
96
14
• The rake industry is an increasing-cost industry
because the average cost of production increases as
the total output of the industry increases.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Long-Run Supply Curve
for an Increasing-Cost Industry
• An increasing-cost industry is an industry in
which the average cost of production
increases as the total output of the industry
increases. The long-run supply curve is
positively sloped.
• The average cost increases as the industry
grows for two reasons:
• Increasing input prices
• Less productive inputs
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Drawing the Long-run
Market Supply Curve
• Each point on the long-run
supply curve shows the
quantity of rakes supplied
at a particular price (i.e., at
a price of $12, 100 firms
produce 700 rakes).
• The long-run industry
supply curve is positively
sloped for an increasing
cost industry.
• As price increases,
supply increases
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Market Equilibrium Revisited
• An increase in demand increases the market price to $17,
causing the typical firm to produce 8 rakes instead of 7.
Price exceeds the short-run average total cost, so
economic profit is positive. Firms will enter the market.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Long-Run Effects
of an Increase in Demand
• In the short-run, firms
respond to the increase
in demand by adjusting
output in their existing
production facilities, and
the price adjusts from
$12 to $17.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
The Long-Run Effects
of an Increase in Demand
• In the long run, after
new firms enter,
equilibrium settles at
$14.
• The new price is a
higher price than the
price before the
increase in demand
(increasing cost
industry).
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e
Long-Run Supply
for a Constant-Cost Industry
• In a constant-cost
industry, firms continue to
buy inputs at the same
prices.
• The long-run supply curve
is horizontal at the constant
average cost of production.
• After the industry expands,
the industry settles at the
same long-run equilibrium
price as before.
© 2003 Prentice Hall Business Publishing
Economics: Principles and Tools, 3/e