perfect competition: short run and long run

8/11/2019 Perfect Competition: Short Run and Long Run

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Prepared by: Jamal Husein

C H A P T E R

5

2005 Prentice Hall Business Publishing Survey of Economics, 2/e OSullivan & Sheffrin

Perfect Competition:Short Run and

Long Run


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2 2005 Prentice Hall Business Publishing Survey of Economics, 2/e OSullivan & Sheffrin

Perfectly Competitive Market

1. There are many firms.

2. The product is standardized, orhomogeneous.

3. Firms can freely enter or leave themarket in the long run.

4. Each firm takes the market price asgiven.

A perfectly Competitive market ischaracterized by:


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The Short-run Output Decision

The firms objective is to produce thelevel of output that will maximize

profit.

Economic profit= total revenue (TR)

minus total economic cost (TC).

Total revenue = price quantity sold.

The cost structure of the business firm

is the same as the one we studied

earlier.


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The Firms TC Structure (Revisited)

The shape of the total cost curve

comes from diminishing returns

in the short run.

STC TFC STVC Short-run

Total Cost=

Total Fixed

Cost+

Short-run

Total Variable

Cost

Total Cos

Short-run

Cost

Variable

Total

Cost

Fixed

Minute

Rakes per

Output:

STCTVCFCQ

360360448361

4812362

5115363

5620364

6327365

7236366

8448367

10165368

12690369

1661303610


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The Revenue Structure of the

Competitive Business Firm

The perfectly competitive firm isa pr ice-taking firm. This meansthat the firm takes the pricefrom the market.

As long as the market remains

in equilibrium, the firm facesonly one pricethe equi l ibr iummarket pr ice.


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Computing the Total Revenue of a

Price-taker

Since the perfectly competitive firmfaces a constant price, the shape of its

total revenue is an upward-sloping

line. Total revenue changes only with

changes in the quantity sold.

($)

Revenue

Total

Price ($)Minute

Rakes per

Output:

TRPQ

0.00250

25.00251

50.00252

75.00253

100.00254

125.00255

150.00256

175.00257

200.00258

225.00259

250.002510

0

50

100

150

200

250

Co

s

t

in

$

0 1 2 3 4 5 6 7 8 9 10

Output: Rakes per minute

Total Revenue


7/297 2005 Prentice Hall Business Publishing Survey of Economics, 2/e OSullivan & Sheffrin

The Totals Approach to Profit Maximization

To maximize profit, aproducer finds thelargest gap between totalrevenue and total cost. ProfitTotal Cost

Short-run

($)

Revenue

Total

Minute

Rakes per

Output:

STCTRQ

-36360.000

-194425.001

24850.002

245175.003

4456100.004

6263125.0057872150.006

9184175.007

99101200.008

99126225.009

84166250.0010



The Marginal Approach

The other way to decide how much

output to produce involves the

marginal principle.

Marginal PRINCIPLEIncrease the level of an activity if its marginal

benefit exceeds its marginal cost, but reduce the

level if the marginal cost exceeds the marginal

benefit. If possible, pick the level at which the

marginal benefit equals the marginal cost.



Marginal Revenue

The benefit of producing and

selling rakes is the revenue the

firm collects. If the firm sellsone more rake, total revenue

increases by $25.

Marginal benefit = marginal

revenue = market price



A firm maximizes

profit in accordance

with the marginal

principleby

setting marginal

revenue (or marketprice) equal to

marginalcost.

ProfitCost

Marginal

Short-run

Price ($)

Revenue =

Marginal

Minute

Rakes per

Output:

SMCPQ-36-250

-198251

24252

243253

445254

627255

789256

9112257

9917258

9925259

84402510

The Marginal Rule for Profit Maximization



Profit Maximization Using the

Marginal Approach



Economic Profit

Profit per unitequals revenue perunit (or price)minus cost per unit

(or average totalcost).

($25 - $14) = 11

Total economic profit equals:

(priceaverage cost) quantity produced

($25 - $14) x 9 = $99



Shut-down Decision

The firm should continue to operate ifthe benefit of operating (total revenue)

exceeds the cost of operating, or total

variable cost.TR = (P Q) must be greater than STVC

= SAVC Q, therefore,I f P > SAVC, the f irm should

continue to operate

I f P < SAVC, the f irm should

shut down



The Shut-down Decision

When price drops to$9, the firm adjusts

output down to 6

rakes per minute to

maintain P=SMC.

The firm suffers a loss, but since priceis

greater than AVC, the firm continues to

operate.

The average

variable cost of

producing 6 rakes

per minute is $6.



The Shut-down Decision

The firms shut-down priceis theprice at which thefirm is indifferent

between operatingand shutting down.

At $5, P = SAVC. Above this price, the firm is

better off continuing to produce at a loss. Belowthis price, the firm is better off shutting down

because it could not recover its operating cost.



Short-run Supply Curve

The firms short-run supplycurveshows the relationship

between the market price andthe quantity supplied by the

firm over a period of time

during which one inputtheproduction facilitycannot

be changed.



The Firms SR Supply Curve

For any price abovethe shut-down price,the firm adjustsoutput along itsmarginal cost curve

as the price levelchanges.

The short-run supply curve is thefirms SMC

curve r ising above the minimum point on the

SAVC curve.

Below the shut-down

price, quantity

supplied equals zero.



The Market Supply Curve

The short-run market supply curveshows therelationship between the market price and thequantity supplied by all firms in the short run.



A Market in Long-run Equilibrium

1. The quantity of the product supplied equals

the quantity demanded

2. Each firm in the market maximizes its profit,

given the market price

3. Each firm in the market earns zero economicprofit, so there is no incentive for other firms

to enter the market

A market reaches a long-run equilibrium whenthree conditions hold:


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In short-run equilibrium, quantitysupplied equals quantity demandedand each firm in the market

maximizes profit. In addition to the conditions above,

in long-run equilibrium the typical

firm earns zero economic profitsothere is no further incentive forfirms to enter the market.


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In long-run equilibrium, price = marginal cost (theprofit-maximizing rule), and price = short-run

average total cost (zero economic profit).

Th LR S l C f


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The LR Supply Curve for an

Increasing-cost Industry

An increasing-cost industryis anindustry in which the average costof production increases as the totaloutput of the industry increases.

The average cost increases as theindustry grows for two reasons:

Increasing input prices

Less productive inputs

I d O d A


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Industry Output and Average

Production Cost

Number of

Firms

Industry

Output

Rakes per

Firm

Typical

Cost for

Typical

Firm

Average

Cost per

Rake

50 350 7 $70 $10

100 700 7 84 12

150 1,050 7 96 14

The rake industry is an increasing-cost industry

because the average cost of production increases

as the total output of the industry increases.

D i th L M k t S l


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Drawing the Long-run Market Supply

Curve

Each point on thelong-run supply curve

shows the quantity of

rakes supplied at a

particular price (i.e.,

at a price of $12, 100

firms produce 700

rakes).

The long-run

industry supply curve

is positively-sloped

for an increasing cost

industry.

SR I i D d d th


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SR Increase in Demand and the

Incentive to Enter

An increase in market demand puts upwardpressure on price. As price increases, there is an

opportunity to earn profit in the short run, and the

industry attracts new firms.

Th L Eff t f I i


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The Long-run Effects of an Increase in

Demand

In the short-run,

firms respond to

the increase in

demand byadjusting output in

their existing

production

facilities, and theprice adjusts from

$12 to $17.

Th L Eff t f I i


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The Long-run Effects of an Increase in

Demand

In the long run,

after new firms

enter, equilibrium

settles at $14. The new price is a

higher price thanthe price before the

increase in demand(increasing costindustry).

L S l C f


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Long-run Supply Curve for an

Constant-cost Industry

In a constant-cost industry, firmscontinue to buy inputs at the same

prices.

The long-run supply curve ishorizontalat the constant average costof production.

After the industry expands, the

industry settles at the same long-run

equilibrium price as before.

Long run Supply Curve for the Ice


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Long-run Supply Curve for the Ice

Industry

In the long-run,

the price of ice

returns to its

original level.

An increase in

the demand for

ice increases the

price of ice to $5per bag.

perfect competition: short run and long run

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