chapter 7 perfect competition
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Chapter 7 Perfect Competition. Econ 1900 Laura Lamb. 7.1 Four market models. Perfect competition Monopolistic competition Oligopoly Pure Monopoly. What are the major characteristics of each market model?. 7.2 Perfect competition. Large number of firms Standardized products Price takers - PowerPoint PPT PresentationTRANSCRIPT
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Chapter 7 Perfect Competition
Econ 1900 Laura Lamb
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1. Perfect competition
2. Monopolistic competition
3. Oligopoly
4. Pure Monopoly
7.1 Four market models
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What are the major characteristics of each market model?
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Large number of firms
Standardized products
Price takers
Easy entry & exit of firms
7.2 Perfect competition
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Then why do we study it?
◦ helps analyze industries with characteristics similar to perfect competition.
◦ provides a context in which to apply revenue and cost concepts developed in previous chapters.
◦ provides a norm or standard against which to compare and evaluate the efficiency of the real world.
Rare in the real world
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Demand is perfectly elastic for each firm◦ Not for the industry◦ Individual firms can sell as much as they want at
the market price
Demand in perfect competition
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Product price Quantity Demanded
Total Revenue Marginal Revenue
8888888
0123456
Demand schedule for a firm
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Average Revenue
Total Revenue
Marginal Revenue
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1. Compare total revenue & total cost
2. Compare marginal revenue & marginal cost
7.3 Profit Maximization in the Short –Run: two approaches
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Total Revenue & Total Cost Schedule
Quantity (cans/day)
Total Revenue ($/day)
Total cost ($/day)
Economic profit($/day)
01234567891011121314
081624324048566472808896
104112
15222730323334363944516076
104144
-15-14-11-607142025282928200
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Consider the market for maple syrup
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Where is the break-even point for the firm?
◦ This is where a normal profit is made◦ No economic profit at this point
Break-even point
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MR = MC rule: in the short run, a firm will maximize profit by producing at the output level where MR = MC.
Method 2
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Quantity (cans/day)
Total Revenue ($/day)
Marginal Revenue
Total Cost ($/day)
Marginal Cost
Economic profit($/day)
01234567891011121314
081624324048566472808896104112
88888888888888
15222730323334363944516076104144
75321123579162840
-15-14-11-607142025282928200
-32
Use the MR=MC Rule
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***The MR=MC rule is applicable to all market models***
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For perfectly competitive firms: MR = MC is equivalent to P= MC
Why?
Note
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1. Suppose the price dropped from $8/can to $6/can, how would the profit maximizing level of output change?
3. Now suppose, the price drops to $4/can. How much should be produced?
Questions
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Quantity (cans/day)
Total revenue
($/day)
MR ($/day) Total cost
($/day)
MC ($/day) Economic profit
(TR-TC)
789101112
283235404448
444444
363944516076
2357916
-8-7-8-11-16-28
At a price of $4/can:
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If a loss is incurred, the firm should continue to produce as long as the price is greater than average variable cost (AVC).
Modified rule: MR = MC if P>minimum AVC
A loss minimizing situation
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In the example of Dave’s Maple Syrup: when P=$8, quantity supplied = 10 when P=$4, quantity supplied = 8
◦ appears rational in light of the law of supply!
◦ The short-run supply curve is the section of the MC curve starting at minimum AVC (and above).
7.4 Marginal cost and the short-run supply curve
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In what situations would the supply curve for the firm shift?
The Supply curve can shift
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Quantity supplied by 1 firm
Total quantity supplied by 1000 firms
Product price Total quantity demanded
10865
10,0008,0006,0005,000
8421
3,0005,0006,00010,000
Equilibrium in the firm & the industry
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Is the industry profitable at the equilibrium?
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1. The firm should produce is P≥minimum AVC
2. The firm should produce the quantity at MR=MC
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Individual firms must take price as given, but the supply plans of all competitive producers as a group are a major determinant of product price.
Firm versus the industry
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Assumptions:1. Entry and exit of firms are the only
long‑run adjustments 2. Firms in the industry have identical cost
curves.3. The industry is a constant‑cost industry
the entry and exit of firms will not affect resource prices or location of unit‑cost schedules for individual firms.
7.5 Profit maximization in the long- run
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**In the long run, product price = minimum ATC
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If P>minimum ATC →economic profits will attract new firms to the industry →increased supply of the product →price is driven down to minimum ATC.
If P<minimum ATC →economic losses will cause some firms to leave the industry →decreased supply of the product →price is driven up to minimum ATC.
Long-run adjustments
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A change in consumer tastes increases the demand for product
trace the steps to a new long-run equilibrium
Illustrate with two graphs, one for the firm and one for the industry.
Example 1
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Household income decreases causing a fall in demand for the product.
trace the steps to a new long-run equilibrium
Illustrate with two graphs, one for the firm and one for the industry.
Example 2
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**In the long run, equilibrium price & quantity always occur where ATC is at a minimum for a perfectly competitive firm.
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The product price will be exactly equal to each firm’s point of minimum average total cost.
Some conclusions about long-run equilibrium
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Perfectly elastic ◦ Level of output does not affect price in the long-
run.
Long-run supply for a constant cost industry
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Upward sloping as industry expands output.
Long-run supply for an increasing cost industry
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Downward sloping as the industry expands output.
Long-run supply for a decreasing cost industry
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In the long run:◦ Productive efficiency occurs where P = minimum
ATC
◦ Allocative efficiency occurs where P = MC allocative efficiency implies maximum consumer and
producer surplus.
7.6 Perfect competition & Efficiency
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When a pharmaceutical company introduces a new drug, it typically owns the patent and can price and produce as a monopolist, earning economic profits.
When patent rights expire, firms pursuing economic profits enter the market for that drug.
Prices of these drugs typically drop 30-40 percent. ◦ Those lower prices increase efficiency and consumer
surplus.
Efficiency Gains from entry of new firms in the pharmaceutical industry