1

Chapter 8Perfect Competition

These slides supplement the textbook, but should not replace reading the textbook

2

What ismarket structure?

Important features of a market, such as the number of firms, product uniformity, ease of entry, and forms of competition

3

What are the four types of Markets?

Perfect Competition

Monopolistic Competition

Oligopoly

Monopoly

4

What is aperfectly competitive

market?homogeneous product

many buyers and sellers

no one has much market power

easy entry & easy exit

can sell all bring to market

5

What is a price taker?

A firm that faces a given market price and whose actions have no effect on that market price

6

Why is a firm that is part of a perfectly

competitive market a price taker?

Because if the firm charges higher than the market price it will not sell even one unit

7

Pri

ce p

er u

nit

Quantity per period

Market Equilibrium in Perfect Competition

D

S

0Exhibit 1a

Surplus

Shortage

8

The Firm’s Demand Curve in Perfect Competition

Market quantity

PS

DIndividual quantity

P

d

8

9

How does the firm maximize profit?

By finding the rate of output that makes total revenue minus total cost as large as possible

10

7

Maximum economic profit = $12

12

TRTC$60

48

15Tota

l d

oll

ars

Quantity per period

Short-Run Profit MaximizationPanel A: TR minus TC

151050Exhibit 3a

11

What is marginal revenue?

The change in total revenue resulting from a one-unit change in sales

12

What is marginal cost?

The change in total cost resulting from a one-unit change in sales

13

At what point are profits maximized?

At the level of output where MR = MC, or the last unit of output where MR > MC

14

Q MR TR TC MC ATC Profit

10 5 50 40.00 2.75 4.00 10.00

11 5 55 43.25 3.25 3.93 11.7512 5 60 48.00 4.75 4.00 12.0013 5 65 54.50 6.50 4.19 10.5014 5 70 64.00 9.50 4.57 6.00

Exhibit 2

Maximizing Profits in the Short-Run

15

Why does MR = P in Perfect Competition?

Because no matter how many units are brought to market, the firm can sell all of them at the market price

16

What isaverage revenue?

Total revenue divided by output

TR / Q

17

Why does AR=P in all markets?

Because each unit is sold for the same price

at one point in time

18

Tota

l d

oll

ars

Quantity per period

Short-Run Profit MaximizationPanel B: MR equals MC

120

$5$4

Profit

d = MR = ARATC

MC

e

a

Exhibit 3b

19

At what point are losses minimized?

At the level of output where MR = MC, or the last unit of output where MR > MC

20

Q MR TR TC MC ATC Loss

8 3 24 35.25 1.50 4.41 -11.25

9 3 27 37.25 2.00 4.14 -10.2510 3 30 40.00 2.75 4.00 -10.0011 3 33 43.25 3.25 3.93 -10.2512 3 36 48.00 4.75 4.00 -12.00

Exhibit 4

Minimizing Losses in the Short-Run

21

What will a firm do if average variable cost exceeds price at every

level of production?

Shut down

22

$40

30

15Tota

l d

oll

ars

Quantity per period

Minimizing Short-Run Losses

151050

Minimum economic loss = $10

TR

TC

Panel A: TC and TR

Exhibit 5a

23

$4.00

3.002.50

151050

Doll

ars

per

un

it

Quantity per period

Minimizing Short-Run Losses

MC

AVC

ATC

d = MR = AR

Panel B: MC equals MR

Exhibit 5b

Loss

24

What is the firm’s short-run supply curve?

A curve that indicates the quantity a firm supplies at each price in the short run

25

Doll

ars

per

un

it

Quantity per period

Summary of Short-Run Output Decisions

p1

p2

p3

p4

p5

q2 q3 q4 q5

MCATC

AVC

Shutdown point

Break-even point

d1

d2

d3

d4

d5

Exhibit 5

26

What is the firm’s short run supply curve?

That portion of its MC curve which lies above its AVC curve

27

Tota

l d

oll

ars

Quantity per period

Relationship between Short-Run Profit Maximization and Market Equilibrium

Panel A: Firm

121050

$54

Profit d=MR

ATCMC = s

Exhibit 8a

AVC

28

What is the industry’s short-run supply curve?

A curve that indicates the quantity all firms in an industry supply at each price in the short run

29

Aggregating Individual Supply to Form Market Supply

Panel A: Firm AP

rice

per

un

it

Quantity per period

p'

p

10 20

0

SA

Exhibit 7a

30

Aggregating Individual Supply to Form Market Supply

Panel B: Firm BP

rice

per

un

it

Quantity per period

p'

p

10 20

0

SB

Exhibit 7b

31

Aggregating Individual Supply to Form Market Supply

Panel C: Firm CP

rice

per

un

it

Quantity per period

p'

p

10 20

0

SC

Exhibit 7c

32

Aggregating Individual Supply to Form Market Supply

Panel D: Industry, or market supply

Pri

ce p

er u

nit

Quantity per period

p'

p

30 60

SA + SB + SC = S

0Exhibit 7d

33

Pri

ce p

er u

nit

Quantity per period

Relationship between Short-Run Profit Maximization and Market Equilibrium

Panel B: Industry, or market

12,0000

$5

D

SMC = S

Exhibit 8b

34

What is economic profit in the long run?

Zero

35

Doll

ars

per

un

it

Quantity per period

Long-Run Equilibrium for the Firm

q0

p d

ATCMCLRAC

e

Exhibit 9a

36

Pri

ce p

er u

nit

Quantity per period

Long-Run Equilibrium for the Industry

Q0

p

D

S

Exhibit 9b

37

What is the long-runindustry supply curve?

A curve that shows the relationship between price and quantity supplied once firms fully adjust to any change in market demand

38

What is an increasing-cost

industry?An industry that faces higher per-unit production costs as industry output expands in the long run

39

Upward sloping

What is the shape of the long-run industry supply

curve in an increasing cost industry?

40

What is production efficiency?

The condition that exists when output is produced with the least-cost combination of inputs, given the state of technology

41

What is allocative efficiency?

The condition that exists when firms produce the output that is most preferred by consumers

42

What is the the marginal cost of each

good equal to?

The marginal benefit consumers derive from that good

43

What is consumer surplus?

The difference between the maximum amount that a consumer is willing to pay for a given quantity of a good and what the consumer actually pays

44

What is producer surplus?

The amount by which total revenue from production exceeds total variable cost

45

Consumer Surplus and Producer Surplus for a Competitive Market in the

Short Run

Doll

ars

per

un

it

Quantity per period

5

$10

0

10,000 20,00012,000

6

e

m

S

D

Consumer surplus

Producer surplus

Exhibit 14

46

END

47

Appendix

48

What is a constant-cost industry?

An industry that can expand or contract without affecting the long-run per-unit cost of production

49

What is the shape of the long-run industry

supply curve?

horizontal

50

Doll

ars

per

un

it

Quantity per period

q0

p d

ATC

MC

LRAC

d'Profit

q'

p'

Panel A: the Firm

Exhibit 10a

Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry

51

Doll

ars

per

un

it

Quantity per period

Long-Run Adjustment to a Decrease in Demand in a Constant Cost

Industry for the Firm

q0

p d

ATCMCLRAC

e

p''

q''

d''Loss

Exhibit 11a

52

Doll

ars

per

un

it

Quantity per period

Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry

Qb0

p

Qc

p'

Qa

S*

S'S

D'D

a

b

c

Exhibit 10b

53

Doll

ars

per

un

it

Quantity per period

Qf0

p''

Qa

p

Qg

S*

SS''

DD''

g a

f

Exhibit 11b

Long-Run Adjustment to a Decrease in Demand in a Constant Cost Industry

54

Pri

ce p

er u

nit

Quantity per periodQb0

pa

pc

pb

QcQa

S*S'SD

D'a

b

c

Exhibit 12b

Long-Run Adjustment to a Increase in Demand in an Increasing Cost Industry

55

Doll

ars

per

un

it

Quantity per periodqb0

pa da

ATC

MC'

a

pc

q

dc

cpb

MC

ATC'db

b

Exhibit 12a

Long-Run Adjustment for the firm to an Increase in Demand in an

Increasing Cost Industry

56

What is a decreasing-cost

industry?The rare case in which an industry faces lower per-unit production costs as industry output expands in the long run

57

Downward sloping

What is the shape of the long-run industry supply

curve in a decreasing cost industry?

58

Doll

ars

per

un

it

Quantity per period

A Decreasing-Cost Industry Adjusts to an Increase in Demand

0

pa

pc

QcQa

S*

S'S

D D'

a

b

c

Exhibit 13