Chapter 8 Perfect Competition ECONOMICS Principles and Applications 4e HALL LIEBERMAN 2008 Thomson South Western Market structure The characteristics of a market that influence how trading takes place 1 How many buyers and sellers 2 Products standardized or significantly different 3 Barriers to entry exit 2 Market structure Types of markets Perfect competition Monopoly Monopolistic competition Oligopoly 3 Perfect Competition Many buyers and sellers no individual decision maker can significantly affect the price of the product Standardized product buyers do not perceive differences between the products Sellers can easily enter exit the market no significant barriers to discourage new entrants 4 Is Perfect Competition Realistic Many markets while not strictly perfectly competitive come reasonably close Perfect competition can approximate conditions and yield accurate enough predictions in a wide variety of markets 5 The Competitive Firm s Demand Curve Horizontal demand curve perfectly elastic at the market price Output is standardized Price taker The price of its output is given Decision How much output to produce and sell 6 The Competitive Firm s Demand Curve Figure 1 The Competitive Industry and Firm 1 The intersection of the market supply and the market demand curve Price per Ounce Market 3 The typical firm can sell all it wants at the market price Price per Ounce S 400 400 D Ounces of Gold per Day 2 determines the equilibrium market price Firm Demand Curve Facing the Firm Ounces of Gold per Day 4 so it faces a horizontal demand curve 7 Cost and Revenue Data Marginal revenue Is the market price Marginal revenue curve The demand curve facing the firm A horizontal line at the market price 8 Profit Maximization Figure 2 Profit Maximization in Perfect Competition a TR TC Dollars TR 2 800 TC Profit TR TC Maximum Profit per Day 700 2 100 550 Slope 400 1 2 3 4 5 6 7 8 9 10 Ounces of Gold per Day 9 Profit Maximization Figure 2 Profit Maximization in Perfect Competition b MR MC Dollars Profit maximization MR MC MC 400 d MR 1 2 3 4 5 6 7 8 9 10 Ounces of Gold per Day 10 Profit Maximization Total Profit TR TC MR MC increase output Maximize profit MR MC Measuring Total Profit Profit per unit P ATC If P ATC the firm earns profit If P ATC the firm suffers a loss 11 Measuring Profit or Loss Figure 3 Measuring Profit or Loss Dollars a Economic Profit Total profit profit per unit Q ATC Profit per unit revenue per unit cost per unit Profit per Ounce 100 MC d MR 400 300 MR MC Q 7 1 2 3 4 5 6 7 8 Ounces of Gold per Day 12 Measuring Profit or Loss Figure 3 Measuring Profit or Loss b Economic Loss Dollars Total loss loss per unit Q Loss per unit cost per unit revenue per unit Loss per Ounce 100 MC MR MC Q 5 ATC 300 200 d MR 1 2 3 4 5 6 7 8 Ounces of Gold per Day 13 The Firm s Short Run Supply Curve The firm takes the market price as given decides how much output to produce at that price Profit maximizing output level P MC As price of output changes firm will slide along its MC curve in deciding how much to produce Exception If the firm is suffering a loss large enough to justify shutting down 14 The Firm s Short Run Supply Curve Figure 4 Short Run Supply Under Perfect Competition a b Dollars Price per ATC Bushel MC 3 50 d1 MR1 3 50 2 50 2 00 d2 MR2 d3 MR3 2 50 2 00 d4 MR4 d5 MR5 1 00 0 50 1 00 0 50 AVC 1 000 4 000 7 000 2 000 5 000 Bushels per Year Firm s Supply Curve 2 0004 000 7 000 5 000 Bushels per Year 15 The Shutdown Price Price at which a firm is indifferent between producing and shutting down If P AVC produce If P AVC shut down Firm s supply curve Is its MC curve for all prices above AVC and a vertical line at zero units for all prices below AVC 16 Competitive Markets in the ShortRun Fixed number of firms in industry Market supply curve Quantity of output all sellers in a market will produce at different prices Add up the quantities of output supplied by all firms in the market at each price 17 Competitive Markets in the Short Run Figure 5 Deriving The Market Supply Curve 3 The total supplied by all firms at different prices is the market supply curve 1 At each price Market Firm Price per Bushel Firm s Supply Curve Price per Bushel 3 50 3 50 2 50 2 00 2 50 2 00 1 00 0 50 1 00 0 50 2 000 4 000 7 000 Bushels per Year 5 000 2 the typical firm supplies the profit maximizing quantity Market Supply Curve 400 000 700 000 Bushels per Year 200 000 500 000 18 Short Run Equilibrium Competitive firms can earn economic profit or suffer an economic loss The market sums buying and selling preferences of individual consumers and producers and determines market price Each buyer and seller Takes market price as given Is able to buy or sell the desired quantity 19 Perfect Competition Figure 6 Perfect Competition Individual Demand Curve Quantity Demanded at Different Prices Quantity Supplied at Different Prices Added together Market Demand Curve Individual Supply Curve Added together Quantity Demanded by All Consumers at Different Prices Quantity Supplied by All Firms at Different Prices Market Supply Curve Market Equilibrium P Quantity Demanded by Each Consumer S D Q Quantity Supplied by Each Firm 20 Perfect Competition Figure 7 Short Run Equilibrium in Perfect Competition 1 When the demand curve is D1 and market equilibrium is here Market Price per Bushel S 3 50 2 00 D1 D2 2 the typical firm operates here earning economic profit in the short run Firm Dollars MC ATC 3 50 Loss per Bushel at p 2 2 00 d1 d2 Profit per Bushel at p 3 50 4 000 7 000 Bushels 400 000 700 000 Bushels per Year per Year 4 the typical firm operates here and 3 If the demand curve shifts to suffers a short run loss D2 and the market equilibrium 21 moves here Competitive Markets in the Long Run New firms can enter the market Existing firms can exit the market Profit and loss in the long run Economic profit outsiders enter the market Economic losses firms exit the market 22 From SR Profit to LR Equilibrium Economic profit attracts new entrants Market supply curve shift rightward Market price falls Demand curve facing each firm shifts downward Each firm decrease output Positive economic profit attracts new entrants until economic profit 0 23 Long Run Equilibrium Figure 8 From Short Run Profit to Long Run Equilibrium Market Firm S1 Price per Bushel A 4 50 With initial supply curve S1 market price is 4 50 Dollars so each firm earns an economic profit 4 50 MC A d ATC 1 D 900 …
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