chapter 7 perfect competition
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Part Two: Microeconomics of Product Markets. CHAPTER 7 PERFECT COMPETITION. In this chapter you will learn:. 7.1 The four basic market structures 7.2 The conditions required for perfectly competitive markets 7.3 How firms in perfect competition maximize profits or minimize losses - PowerPoint PPT PresentationTRANSCRIPT
Slides prepared by Dr. Amy Peng, Ryerson University
CHAPTER 7CHAPTER 7PERFECT PERFECT
COMPETITIONCOMPETITION
Part Two: Microeconomics Part Two: Microeconomics of Product Marketsof Product Markets
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7 2
In this chapter you will learn:In this chapter you will learn:
7.1 The four basic market structures 7.2 The conditions required for perfectly
competitive markets7.3 How firms in perfect competition
maximize profits or minimize losses7.4 Why the marginal cost curve and
supply curve of competitive firms are the same
7.5 About the firm’s profit maximization in the long run
7.6 About the efficiency of competitive markets
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.1 3
Four Market StructuresFour Market Structures
• Perfect Competition• Monopoly• Monopolistic Competition• Oligopoly
OligopolyOligopoly
Market Structure ContinuumMarket Structure Continuum
PurePureCompetitionCompetition
PurePureMonopolyMonopoly
MonopolisticMonopolisticCompetitionCompetition
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.2 4
Market Structure ContinuumMarket Structure Continuum
PurePureCompetitionCompetition
PurePureMonopolyMonopoly
MonopolisticMonopolisticCompetitionCompetition OligopolyOligopoly
Characteristics of Perfect Characteristics of Perfect CompetitionCompetition
• Very Large Numbers• Standardized Product• Price-Takers• Easy Entry and Exit
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.2 5
Demand for a Firm in Perfect Demand for a Firm in Perfect CompetitionCompetition
• Perfectly Elastic Demand• Average, Total, and Marginal
Revenue– average revenue = price– marginal revenue = price– total revenue = price x quantity
Illustrated…Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.2 6
Product price, P
(average revenue)
Quantity demanded,
Q
Total Revenue,
TR
Marginal Revenue,
MR
131 0 0
131 1 131
131 2 262
131 3 393
131 4 524
131 5 655
131 6 786
131 7 917
131 8 1048
131 9 1179
131 10 1310
Product price, P
(average revenue)
Quantity demanded,
Q
Total Revenue,
TR
Marginal Revenue,
MR
131 0
131 1
131 2
131 3
131 4
131 5
131 6
131 7
131 8
131 9
131 10
]] 131131
]] 131131
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©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.2 7
Figure 7-1 The Demand and Revenue Figure 7-1 The Demand and Revenue Curves Curves
for a Firm in Perfect Competitionfor a Firm in Perfect Competition
D = MR = AR
TR
1179
1048
917
786
655
524
393
262
131
0Quantity Demanded
2 4 6 8 10 12
Pri
ce a
nd r
evenu
e
Demand is perfectly elastic since the firm can sell as much output as it wants at the market price
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 8
Profit Maximization in the Short Profit Maximization in the Short RunRun
• Purely competitive firm can maximize its profit (minimize its loss) only by adjusting output
Two Approaches:• total revenue-total cost
approach• marginal revenue-marginal cost
approach
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 9
Q TFC TVC TC TRProfit or
Loss
0
1
2
3
4
5
6
7
8
9
10
Q TFC TVC TC TRProfit or
Loss
0 $100
1 100
2 100
3 100
4 100
5 100
6 100
7 100
8 100
9 100
10 100
Q TFC TVC TC TRProfit or
Loss
0 $100 $ 0
1 100 90
2 100 170
3 100 240
4 100 300
5 100 370
6 100 450
7 100 540
8 100 650
9 100 780
10 100 930
Q TFC TVC TC TRProfit or
Loss
0 $100 $ 0 $ 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030
Q TFC TVC TC TRProfit or
Loss
0 $100 $ 0 $ 100 $ 0
1 100 90 190 131
2 100 170 270 262
3 100 240 340 393
4 100 300 400 524
5 100 370 470 655
6 100 450 550 786
7 100 540 640 917
8 100 650 750 1048
9 100 780 880 1179
10 100 930 1030 1310
Q TFC TVC TC TRProfit or
Loss
0 $100 $ 0 $ 100 $ 0 $-100
1 100 90 190 131 - 59
2 100 170 270 262 - 8
3 100 240 340 393 + 53
4 100 300 400 524 +124
5 100 370 470 655 +185
6 100 450 550 786 +236
7 100 540 640 917 +277
8 100 650 750 1048 +298
9 100 780 880 1179 +299
10 100 930 1030 1310 +280
p=$131p=$131p=$131p=$131
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 10
Profit Maximization, Pure Competition
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
0 2 4 6 8 10 12 14
Quantity
$
TCTCTRTRTRTRMaximum Maximum economic profit economic profit
$299$299
Maximum Maximum economic profit economic profit
$299$299
Break-even point (normal Break-even point (normal profit)profit)
Break-even point (normal Break-even point (normal profit)profit)
Break-even pointBreak-even pointBreak-even pointBreak-even point
Figure 7-2Figure 7-2
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 11
Total Revenue-Total Cost Total Revenue-Total Cost ApproachApproach
• Profit = TR - TC• Profit is maximized where the
vertical distance between TR and TC is maximized
• Break-even points are where TR=TC
• Now, the marginal revenue-marginal cost approach…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 12
Q TFC TVC TC
0 $100 $ 0 $ 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030
MC
$ 90
80
70
60
80
90
110
130
150
]]]]]]]]]]]]]]]]
]]
Figure 7-3Figure 7-3
MC MR
$ 90
$131
80 131
70 131
60 131
80 131
90 131
110 131
130 131
150 131
Should the Should the firm produce firm produce the 1the 1stst unit? unit?
Should the Should the firm produce firm produce the 1the 1stst unit? unit?What about What about the 2the 2ndnd unit? unit?What about What about the 2the 2ndnd unit? unit?
What about What about the 9the 9thth unit? unit?What about What about the 9the 9thth unit? unit?
9 units will maximize profitsthe same profit-maximizing resultas with the TR-TC approach!
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 13
Marginal Revenue-Marginal Cost Marginal Revenue-Marginal Cost ApproachApproach
Short run profit maximization occurs where MR=MC:
1. Rule applies only if producing is preferable to shutting down
2. Rule is an accurate guide to profit maximization for ALL firms
3. Rule can be restated as P=MC for purely competitive firms, since MR=P
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 14
Figure 7 - 3
0
40
80
120
160
200
0 2 4 6 8 10
Output
Cos
t & R
even
ue
MCMC
ATCATC
AVCAVC
AFCAFC
9
131131
Find the Find the quantityquantitywhere MR=MCwhere MR=MC
97.7897.78
Find ATCFind ATC
Profit = 9 X (131 - 97.78) = 299
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 15
Loss-Minimizing CaseLoss-Minimizing Case
• Suppose price falls from $131 to $81…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 16
Q TFC TVC TC
0 $100 $ 0 $ 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030Figure 7-4Figure 7-4
MC MR
$ 90
$81
80 81
70 81
60 81
80 81
90 81
110 81
130 81
150 81
]]]]]]]]]]]]]]]]
]]
Firm should Firm should produce the produce the first 6 unitsfirst 6 units
Firm should Firm should produce the produce the first 6 unitsfirst 6 units
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7 17
Figure 7 - 4
0
40
80
120
160
200
0 2 4 6 8 10
Output
Cos
t & R
even
ue
MCMC
ATCATC
AVCAVC
AFCAFC
818191.6791.67
Loss = 6 X (81 - 91.67) = -64.02 < TFC
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 18
Shutdown CaseShutdown Case
• Suppose the price falls even further, to $71…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3 19
Figure 7- 5
0
40
80
120
160
200
0 2 4 6 8 10
Output
Cos
t & R
even
ue
MCMC
ATCATC
AVCAVC
AFCAFC
7171
9494Loss = 5 X (71 - 94) = -115>TFC
5When price is belowWhen price is below
minimum AVC, the firm minimum AVC, the firm should shut downshould shut down
When price is belowWhen price is belowminimum AVC, the firm minimum AVC, the firm
should shut downshould shut down
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 20
PP
MCMCATCATCC
ost
s an
d r
even
ues
(d
oll
ars)
Co
sts
and
rev
enu
es (
do
llar
s)
At every price, theAt every price, theMR = MC pointMR = MC point
indicates the quantityindicates the quantitybeing produced...being produced...
At every price, theAt every price, theMR = MC pointMR = MC point
indicates the quantityindicates the quantitybeing produced...being produced...
AVCAVC
Figure 7-6 Figure 7-6 Marginal Cost and Short-Run SupplyMarginal Cost and Short-Run Supply
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 21
PP
MCMCATCATC
Record theRecord thequantity beingquantity being
supplied forsupplied foreach priceeach price
Co
sts
and
rev
enu
es (
do
llar
s)C
ost
s an
d r
even
ues
(d
oll
ars)
PP33 MRMR33
QQ33
AVCAVC
Marginal Cost and Short-Run Marginal Cost and Short-Run SupplySupply
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 22
PP
MCMCATCATC
MRMR22
MRMR33PP22
PP33
QQ22 QQ33
At a lower priceAt a lower pricea lower quantitya lower quantitywill be suppliedwill be supplied
At a lower priceAt a lower pricea lower quantitya lower quantitywill be suppliedwill be supplied
Co
sts
and
rev
enu
es (
do
llar
s)C
ost
s an
d r
even
ues
(d
oll
ars)
AVCAVC
Marginal Cost and Short-Run Marginal Cost and Short-Run SupplySupply
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 23
PP
MCMCATCATC
MRMR22
MRMR33
MRMR44
PP22
PP33
PP44
QQ33QQ44
At a higher priceAt a higher pricea higher quantitya higher quantitywill be suppliedwill be supplied
At a higher priceAt a higher pricea higher quantitya higher quantitywill be suppliedwill be supplied
QQ22
Co
sts
and
rev
enu
es (
do
llar
s)C
ost
s an
d r
even
ues
(d
oll
ars)
AVCAVC
Marginal Cost and Short-Run Marginal Cost and Short-Run SupplySupply
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 24
PP
PP11
MCMC
MRMR11
AVCAVC
ATCATC
MRMR22
MRMR33
MRMR44
MRMR55
PP22
PP33
PP44
PP55
QQ22 QQ33QQ44 QQ55
Firm should notFirm should notproduce produce below Pbelow P22
Firm should notFirm should notproduce produce below Pbelow P22
Co
sts
and
rev
enu
es (
do
llar
s)C
ost
s an
d r
even
ues
(d
oll
ars)
Marginal Cost and Short-Run Marginal Cost and Short-Run SupplySupply
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 25
PP
PP11
MCMC
MRMR11
AVCAVC
ATCATC
MRMR22
MRMR33
MRMR44
MRMR55
PP22
PP33
PP44
PP55
QQ22 QQ33QQ44 QQ55
Co
sts
and
rev
enu
es (
do
llar
s)C
ost
s an
d r
even
ues
(d
oll
ars)
Short-runShort-runsupply curvesupply curve(Above AVC)(Above AVC)
Short-runShort-runsupply curvesupply curve(Above AVC)(Above AVC)
Marginal Cost and Short-Run Marginal Cost and Short-Run SupplySupply
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 26
Marginal Cost and Short-run Marginal Cost and Short-run SupplySupply
• Firm’s short-run supply curve is the portion of its MC curve above minimum AVC
• Diminishing Returns, Production Costs, and Product Supply
• Supply curve shifts:– A wage increase shifts the supply curve
upward and to the left (decreasing in supply)– Technological progress would shift the
supply curve downward to the right (increasing in supply)
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 27
MCMC
AVCAVC
88
DD
80008000
DD
$111$111$111$111
1000 firms1000 firms
IndustryIndustryFirmFirm
(price taker)(price taker)
QQ QQ
PP PPS=S=MCs MCs
Figure 7-7Figure 7-7Competitive Equilibrium for a Firm and Competitive Equilibrium for a Firm and
the Industrythe Industry
ATCATCEconomicEconomic
ProfitProfitEconomicEconomic
ProfitProfit
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4 28
Table 7-4 Output Determination in Table 7-4 Output Determination in Perfect Competition in the Short RunPerfect Competition in the Short Run
Question AnswerShould this firm produce?
Yes, if P ≥ minimum ATC; this means that the firm is profitable or that its losses are less than its fixed cost
What quantity should the firm produce?
Produce where MR (=P) = MC; there, profit is maximized or loss is minimized
Will production result in economic profits?
Yes, if P > ATC (TR > TC)
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 29
Profit Maximization in the Long Profit Maximization in the Long RunRun
• Assumptions:– Entry and Exit Only– Identical Costs– Constant-Cost Industry
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 30
The Goal of Our AnalysisThe Goal of Our Analysis
• In the long run, p = minimum ATC
• Because:1. Firms seek profit and avoid losses2. Firms are free to enter and exit
the industry
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 31
PP
MCMC PP
SS11
IndustryIndustry1000 firms1000 firms
FirmFirm(price taker)(price taker)
ATCATC
MRMR$60$60$50 $50 $40$40
100100
$60$60$50 $50 $40$40
100,000100,000
DD11
Figure 7-8 Figure 7-8 Entry Eliminates Economic ProfitsEntry Eliminates Economic Profits
DD22
Economic Profits
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 32
PP
MCMCPP
DD11
SS11
ATCATC
MRMR$60$60$50 $50 $40$40
100100
$60$60$50 $50 $40$40 DD22
100,000100,000
SS22
IndustryIndustry110,000 firms110,000 firms
FirmFirm(price taker)(price taker)
Entry Eliminates Economic ProfitsEntry Eliminates Economic Profits
110,000110,000
New Equilibrium with more firmsNew Equilibrium with more firms
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 33
PP
MCMC PP
DD11
SS11
ATCATC
MRMR$60$60$50 $50 $40$40
100100
$60$60$50 $50 $40$40
100,000100,000
IndustryIndustry1000 firms1000 firms
FirmFirm(price taker)(price taker)
Figure 7-9 Exit Eliminates LossesFigure 7-9 Exit Eliminates Losses
DD22
Economic Loss
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 34
PP
MCMC PP
DD11
SS11
ATCATC
MRMR$60$60$50 $50 $40$40
100100 90,00090,000
DD22
SS33
100,000100,000
$60$60$50 $50 $40$40
IndustryIndustry90,000 firms90,000 firms
FirmFirm(price taker)(price taker)
Exit Eliminates LossesExit Eliminates Losses
New equilibrium with fewer firmsNew equilibrium with fewer firmsNew equilibrium with fewer firmsNew equilibrium with fewer firms
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 35
Long-Run EquilibriumLong-Run Equilibrium
• If price > min ATC– profits attract new firms– as S increases, price drops to min
ATC
• If price < min ATC– losses cause firms to exit– as S decreases, price rises to min
ATC
• So, in the long run, p = min ATC
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 36
Long-run SupplyLong-run Supply
• Crucial factor is whether the number of firms in the industry affects the costs of individual firms
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 37
P=$50P=$50
DD11
QQ11
SS11
QQ22
PP
Figure 7-10 Long-run Supply for a Figure 7-10 Long-run Supply for a Constant-Cost Industry Is HorizontalConstant-Cost Industry Is Horizontal
DD22
Demand Demand increasesincreasesDemand Demand increasesincreases
P>$50P>$50
DD22
QQ22
Profits Profits attract new attract new
firmsfirms
Profits Profits attract new attract new
firmsfirms
Price remains the same in the long runPrice remains the same in the long runPrice remains the same in the long runPrice remains the same in the long run
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 38
PP
P=$50P=$50
DD11
QQ11
Figure 7-11 Long-run Supply for an Figure 7-11 Long-run Supply for an Increasing-Cost Industry Is UpslopingIncreasing-Cost Industry Is Upsloping
SS11 Demand Demand increasesincreasesDemand Demand increasesincreases
DD22
P>>$50P>>$50
QQ22
Profits Profits attract new attract new
firmsfirms
Profits Profits attract new attract new
firmsfirms
In the long run, greater supply is offered at a In the long run, greater supply is offered at a higher pricehigher price
In the long run, greater supply is offered at a In the long run, greater supply is offered at a higher pricehigher price
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5 39
PP
P=$50P=$50
DD11
QQ11
Long-run Supply for a Decreasing-Long-run Supply for a Decreasing-Cost Industry Is DownslopingCost Industry Is Downsloping
SS11 Demand Demand increasesincreasesDemand Demand increasesincreases
DD22
P>$50P>$50Profits Profits
attract new attract new firmsfirms
Profits Profits attract new attract new
firmsfirms
P<$50P<$50
QQ22
long-run Slong-run S
In the long run, greater supply is offered at a In the long run, greater supply is offered at a lower pricelower price
In the long run, greater supply is offered at a In the long run, greater supply is offered at a lower pricelower price
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6 40
Figure 7-12 Figure 7-12 Pure Competition and EfficiencyPure Competition and Efficiency
PP
PP MRMR
MCMCATCATC
Price = MC = Minimum ATCPrice = MC = Minimum ATC(normal profit)(normal profit)
Price = MC = Minimum ATCPrice = MC = Minimum ATC(normal profit)(normal profit)
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6 41
• Productive Efficiency– P = Minimum ATC
• Allocative Efficiency– P = MC
Pure Competition and EfficiencyPure Competition and Efficiency
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6 42
Allocative Efficiency andAllocative Efficiency andConsumer and Producer SurplusConsumer and Producer Surplus
• Consumer Surplus is the difference between what the consumer is willing to pay and the market price
• Producer Surplus is the difference between the marginal cost of production and the market price
• At equilibrium, consumer and producer surplus is maximized
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6 43
Figure 7-12 Long-Run Equilibrium:Figure 7-12 Long-Run Equilibrium:A Competitive Firm and MarketA Competitive Firm and Market
PP
PPee
QQee
Consumer Surplus
Producer Surplus
The sum of consumer and producer surplus is maximized
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6 44
• Productive Efficiency– P = Minimum ATC
• Allocative Efficiency– P = MC
• Dynamic Adjustments– purely competitive markets adjust
to restore efficiency when disrupted by changes in the economy
Pure Competition and EfficiencyPure Competition and Efficiency
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6 45
The “Invisible Hand” RevisitedThe “Invisible Hand” Revisited
• The efficient allocation of resources in perfect competition comes about because businesses and resource suppliers seek to further their self-interest
• Both business profits and consumer satisfaction are maximized
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7 46
Chapter SummaryChapter Summary
7.1 Four Market Structures 7.2 Characteristics of Pure Competition
and the Firm’s Demand Curve 7.3 Profit Maximization in the Short Run
– MR ( = P) = MC ; TR – TC is the highest 7.4 Marginal Cost and Short-Run Supply
– Firm’s short-run MC that Lies above its AVC 7.5 Profit Maximization in the Long Run 7.6 Pure Competition and Efficiency
– P = ATC = MC