Transcript Unit 4 Pure Competition Powerpoint 2

The Story of Pure Competition
• The Green Bean Market
• Perfection: Most Efficient (3 Ways)
production
economic
allocation of scarce resources
• The most output, at the least cost, with no
shortages and surplus or mis-allocation of
valuable resources.
Characteristics of a Perfectly
Competitive Market Structure
Assumptions that affect the behaviors of the
firm
Many small firms who by themselves do not
affect the industry
All firms produce an identical product
Consumers and all firms know that the
products are identical and what price is:
Total knowledge
Firms can enter and exit easily because they
are small and have little invested
Results
for every firm
• Price taker
• No market power
• Most efficient: Produces at
– Price=mr=mc @min. of long run ATC
The Demand Curve
for Green Bean Producers
The interaction of market
supply and demand yields
an equilibrium price of $5
and quantity of 25,000 units
Neither an individual
buyer or seller can
influence the price
S
D
0
10,000 20,000 30,000 40,000 50,000
Green Beans
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 sell zero units if it wants a
higher price
– Cannot sell more units at a lower
price
Industry and the firm side by
side Explain why Price=d
Industry
Individual firm
S
E
5
d
5
D
0
10,000 20,000 30,000 40,000 50,000
Green Beans
0
1
2
3
Green Beans
4
5
How Much Should
the Perfect Competitor Produce?
Explain why P=d=AR
• The firm will produce the level of output that
will maximize profits given the market price.
Economic profit = total revenue (TR) - total cost (TC)
• Total Revenues
– The price per unit times the total
quantity sold
Price X Quantity
How Much Should
the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TR = P x Q
TR
PQ
P
Average revenue (AR) 

Q
Q
P determined by the market in perfect competition
Q determined by the producer to maximize profit
Now Why Price=d=AR=MR=MC
How Much Should
the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TC  explicit + opportunity cost
Profit Maximization
Figure 23-3, Panel (a)
Profit Maximization
Where TR-TC is the greatest
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 23-3, Panel (b)
How Much Should the Perfect
Competitor Produce?
Therefore
• Profit-maximizing rate of production
– Firm sets production where it can
maximizes total profits
–Which is where
– the difference between total revenues
and total costs is the greatest
TR-TC= greatest
– the rate of production at which marginal
revenue equals marginal cost MC=MR
Profit Maximization
TR-TC= greatest matches
where MR=MC
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 23-3, Panel (c)
Using Marginal Analysis to
Determine
the Profit-Maximizing Rate of
Production
∆TR
Marginal revenue (MR)  ∆output
∆TC
Marginal cost (MC)  --------∆output
Using Marginal Analysis to
Determine
the Profit-Maximizing Rate of
Production
• Left side of graph
• MR > MC
• TR is increasing
more than TC
• and profits are
increasing as you
increase output
MR > MC
Using Marginal Analysis to
Determine
the Profit-Maximizing Rate of
Production
• Right side of
graph
• MC > MR
• TC is
increasing more
than TR
• profits are
decreasing.
MR > MC
MC > MR
Profit Maximization
Total
Output/
Sales/
day
Total
Costs
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
Market
Price
Total
Revenue
Total
Profit
Marginal
Cost
Marginal
Revenue
$5
$5
3
5
2
5
1 MR > MC
5
2
5
3
5
4
5
5 MR = MC
5
6
5
7 MR < MC
5
8
5
Using Marginal Analysis to
Determine
the Profit-Maximizing Rate of
Production
We have proven why you produce
at MR=MC
• Profit maximization—a review
– TR  TC= greatest
– And this matches to where
– at the unit that MC = MR
• For a perfectly competitive firm,
–Price =d=AR=MR and now its
marginal cost curve
Short-Run Profits
• Profit is maximized where
MR = MC
• ATC = TC/output
• TC = ATC  output
• TR = P  output
• Profit = (P - ATC)  output
14
13
12
11
MC
10
9
8
7
ATC
Profits
6
d
5
P = MR = AR
4
3
2
1
0
Figure 23-4
1
2
3
4
5
6
7
8
9 10 11 12
Minidisks per Day
Short-Run Profits
• At P = $5,
ATC = 4.33
•
MC Output = 7.5 units
14
13
12
11
10
9
• TR = $5 ´ 7.5 =
37.5
8
7
ATC
Profits
6
d
P = MR = AR •
5
4
3
2
1
1
0
2
3
4
5
6
7
8
9 10 11 12
TC = $4.33 ´ 7.5 =
32.5
•
Profit = 37.5 - 32.5 =
$5 or ($5 - 4.33) ´
7.5 = $5
Losses OK if Price above AVC
• Losses are minimized
where MR = MC
• Loss = ($3 - 4.35)  5.5 or
$7.43
14
Price and Cost per Unit ($)
13
12
11
MC
10
9
8
7
6
ATC
Losses
d1
5
4
d2
3
2
1
P = MR = AR
Loss Minimization of ShortRun Profits
MC
9
8
7
6
ATC
Losses
d1
5
4
d2
3
P = MR = AR
2
1
0
1
2
3
4
5
6
7
8
9 10 11 12
Therefore Short-Run
Firm will operate in SR
• Where Price=d=ar=mr=mc
at or above AVC
• make economic
profits or economic
losses.
Short-Run Shutdown
and Break-Even Price
Short-run break-even point
If Price goes
below AVC
Short-run
shutdown point
• 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: Cheaper to shut down
and just pay FC
– It occurs just below the intersection
of the marginal cost curve and the
average variable cost curve
The Meaning
of Zero Economic Profits
–Distinguish between economic
profits and accounting profits
–When economic profits are
zero, accounting profits are
positive
– Normal profits and zero economic
profits because you are paying your
bills and paying yourself
The Perfect Competitor’s
Short-Run Supply Curve
• the firm’s supply curve is the marginal cost
curve above the short-run shutdown point. Or
MC above min. of AVC
– in a competitive industry is its marginal costs
curve equal to and above the point of intersection
with the average variable cost curve.
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
The Perfect Competition
Industry ALL FIRMS
Short-Run Supply Curve
• Factors that influence the industry supply
curve (determinants of supply): NON
PRICE DETERMINANTS
• For the individual firm---if it effects costs
then the supply curve or MC will shift up
if costs go up and down if costs go down
– Firm’s productivity
– Factor costs
– Taxes and subsidies
The Perfect Competitors Industry
Short-Run Supply Curve all
firms production at a certain
price
Figure 23-8, Panels (a), (b), and (c)
Therefore the Supply curve for
the Industry
– The market supply curve is equal to
the horizontal summation of the
portions of the individual marginal
cost curves above their respective
minimum average variable costs
– ADD ALL THE MC’s output at a price
for all the firms
– Supply curve is the Sum of all MC’s
=>AVC
Competitive Price
Determination
Pe is the price
the firm must take
The Long-Run Industry Situation:
• Look at all the factors that the firm uses
• Produce at one point only where MR=MC at
the min. of LRATC
• If above this point: clear profit will cause new
firms to enter the industry---therefore supply
shifts to the right and price automatically
comes down. adjustment
• If below LRATC then firm exit the
industry==goes out of business adjustment
Therefore in the long run
• Profits and losses act as signals for
resources to enter an industry or to
leave an industry.
• Clear profit==enter
• Loses =exit
The Adjustment Graphically
cool
MC
S
ATC
Break-even
D
Quantity of Wheat
(industry)
qe
Quantity of Wheat
(firm)
A European crop failure increases
the demand for U.S. wheat
European crop failure increases the Demand for U.S. wheat
MC
S1
ATC
D2
D1
Q1
Quantity of Wheat
(industry)
Higher price creates
economic profit
q1 q2
Quantity of Wheat
(firm)
New firms enter to get those
profits: new lower price
Second thing to heppen-----Economic profit attracts new firms
In the industry prices fall the firm takes the new lower price
Price fall to break-even
MC
S1
S2
ATC
P1
D2
D1
Q1
Quantity of Wheat
(industry)
q1
Quantity of Wheat
(firm)
The Adjustment Graphically: oh no
loses, and exit
What will happen to supply
Price of Wheat ($)
What happens if for some
firms prices fall too low
Reaction
S to losses
MC
ATC
ATC
Pe
d = MR
D
Qe
Quantity of Wheat
(industry)
qe
Quantity of Wheat
(firm)
The Adjustment Graphically
Losses signal for resources to leave the market
Supply falls and price increases to break-even
Price of Wheat ($)
S2
MC
S1
ATC
P2
P1
d = MR
Break-even
D
Q1
Quantity of Wheat
(industry)
q1
Quantity of Wheat
(firm)
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
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
firms will make zero economic profits
(normal rate of return)
The Long-Run Industry Situation:
Exit and Entry
• Long-Run Industry Supply Curve
– A market supply curve showing the
relationship between price and quantities
– after firms have been allowed time to enter
or exit from an industry
– For individual firms it is one point at min of
ATC where MC=MR
Different types of Industries
• Constant-Cost Industry
– An industry whose total output can be increased
without an increase in long-run per-unit costs
• Decreasing-Cost Industry
– An industry in which an increase
in industry output leads to a reduction
in long-run per unit costs
• Increasing-Cost Industry
– An industry in which an increase in industry output
is accompanied by an increase in long-run per unit
costs
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
– Without externality or market failure
Marginal cost Pricing
eliminates failures or corrects
them
• If too much of a product is produced
that is harmful to society
• Problem that too many resources are being
used to produce something harmful
• Price too low and consumers are buy the bad
• Correction tax the producers
• You are shifting the supply curve up ---MC
Marginal Cost Pricing to
correct problem
• Too little is being produced at too high a
price to consumers--this is something
that society might benefit from
– Too few resources are being used
– Price too high
– Correction subsidize the consumers --shift
demand or subsidize the producers
• Analyze the consequences