topic 5 - pc
TRANSCRIPT
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Perfect CompetitionTopic 5
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Character ist ics
Pure Compet it ion large number of sellers & buyers homogenous (identical) products low barriers to entry (free entry and exit from
the industry)
Perfect Competi t ion
large number of sellers & buyers homogenous (identical) products low barriers to entry perfect market knowledge
perfect mobility of FoPs
Lead tofaster
adjustment
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Price takers & Price makers
Demand curve for aPrice taker
Demand curve for aPrice maker
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Demand curve for a Price taker
The demand curve facing a perfectlycompetitive firm is perfect ly elast ic,meaning that the firm can sell as many units
as it wants at the market price, but cannotsell any quantity if it charges more than themarket price.
The firm has no market power, no pricingpower at all. It is just a small player in alarge market.. It is a pr ice taker.
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Demand curve for a Price maker
Downward sloping. It is just matter of how steep the curve is.
The more market power a firm has, the
steeper is the demand curve. The characteristic of a downward sloping
demand curve is that, normally, if a firm
raises the price of its product, it needs notlose all its customers, and if it wants to sellmore, it has to cut price.
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Demand curve for Individual firmunder PC
P = AR = MR
Firms D curve
Market D curve
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Revenue Concepts under PC
Total revenue (TR): Total number of dollars (or dong)received by a firm from the sale of a product.
TR = P x Q
Average revenue (AR): Total revenue per unit of aproduct sold
AR = TR/Q = (P x Q) / Q = P
Marginal Revenue (MR): Additional revenue receivedresulting from the sale of an extra unit of output
MR = = = PTR
Q
P. Q
Q
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$131131131
131131131131131131131131
012
3456789
10
$ 0131262
393524655786917
104811791310
]$131
131
131131131131131
131131131
]
]
]
]
]
]
]
]
]
ProductPrice
(AverageRevenue)
TotalRevenue
MarginalRevenue
QuantityDemanded
(Sold)
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TR
Price,averagea
ndmarginalrevenue,
totalrevenue(dollars)
P
Quantity demanded (sold)1 2 3 4 5 6 7 8 9 10
917
786
655
524
393
262
131
0
D = MRP = AR = MR
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Profit Maximisation in theSho rt Run
Two approaches to pro f i t maxim isat ion:
Total Revenue minus Total Cost Approach
Marginal Revenue, Marginal Cost
Approach
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IMPORTANT!Rules for Profit Maximisation
Optimum output where: TR TC = largest
or
Optimum output where: MR = MC
or MR closest to MC but MR > MC
MC cuts MR curve from below
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Total Revenue Total CostApproach (Price = $131)
01
23456
789
10
TotalCost
TotalProduct
TotalFixedCost
TotalVariableCost
TotalRevenue Profit
$ 100100
100100100100100
100100100100
$ 090
170240300370450
540650780930
$ 100190
270340400470550
640750880
1030
$ 0131
262393524655786
917104811791310
$100 59
8+ 53
+ 124+ 185+ 236
+ 277+ 298+ 299+ 280
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01
23456
789
10
100
100
100
100
100
100
100
100100
100
100
0
90
170
240
300
370
450
540650
780
930
100190
270340400470550
640750880
1030
]
]]]]]]
]]
]
TotalCost
TotalProduct
TotalFixedCost
TotalVariableCost
MarginalCost
TotalEconomicProf./Loss
Price =MarginalRevenue
Profit Maximisation: MR, MC Approach
90
8070607080
9011013
015
0
$ 131
131131131131131
131131131131
$100
59 8
+ 53+ 124+ 185+ 236
+ 277+ 298+ 299+ 280
S f f
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fig
O O
S
D
(a) Industry
P $
Q (millions)
Pe
(b) Firm
AR D = AR
= MR
MC
Qe
Short-run equilibrium ofindustryandfirmunder Perfect Competition
Q (thousands)
Copyright 2001 Pearson Education Australia
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IMPORTANT!Rules for Profit Maximisation
Optimal ou tpu t is where MR = MC
or MR closest to MC but MR > MC
MC cuts MR curve from below
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IMPORTANT !Rules for Profit maximization
Sho rt Run
P AVC
In the short run, fixed costs will be incurredwhether or not the firm produces. So thismeans that total revenue must be at leastequal to total variable cost for the firm tocontinue producing.
If P < AVC, firm should shut down
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IMPORTANT !Rules for Profit maximization
Long Run
P ATC
In the long run, firms have the option ofclosing down and going out of business, sototal revenue must at least cover total costs
( all costs ).If P < ATC, firm should shut down
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fig
O O
S
D
(a) Industry
P $
Q(millions)
Pe
(b) Firm
AR D = AR
= MR
MC
Qe
ATC
AC
SR Profit maximisation underPerfect Competition
Q(thousands)
Copyright 2001 Pearson Education Australia
S f
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fig
O O
S
D
(a) Industry
P $
Q(millions)
Pe
(b) Firm
AR D = AR= MR
MC
Qe
ATC
AC
SR Profit maximisation underPerfect Competition
Q(thousands)
Copyright 2001 Pearson Education Australia
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fig
O O
(a) Industry
P $
P1
Q(millions)
S
D
(b) Firm
AR1D1= AR1
= MR1
MC
Qe
ATC
AC
SR Loss minimisation underPerfect Competition
Q(thousands)
Copyright 2001 Pearson Education Australia
AV
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fig
Short-run shut-down point
O O
(a) Industry
P $
P2
Q(millions)
S
D2
(b) Firm
AR2
D2= AR2
= MR2
MC ATC
AV
Q
Copyright 2001 Pearson Education Australia
Q1
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Long runEquilibrium under PC
Under PC
P = min. ATC = MR = MCwhy?
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fig
Long-run equilibrium under PC
O OD
(a) Industry
P $
Q(millions)
P1
(b) Firm
ATC
AR1
S1
D1
Q(thousands)
Copyright 2001 Pearson Education Australia
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fig
O O
S1
D
(a) Industry: As firms makingsupernormal profits , new firmswill enter the industry. S curve
shifts to right. Price falls.
P $
Q(millions)
P1
(b) Firm
AR1
ATC
PL ARL
QL
Se
D1
DL
Long-run equilibrium under PC
Q(thousands)
Copyright 2001 Pearson Education Australia
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fig
O O
S1
D
(a) Industry: As firms makinglosses , some firms will leavethe industry. S curve shifts to
left. Price rises.
P $
Q(millions)
P1
(b) Firm
AR1
ATC
PL ARL
QL
Se
D
1
DL
Long-run equilibrium under PC
Q(thousands)
Copyright 2001 Pearson Education Australia
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Long run Equilibrium
.
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Long run Equilibrium
Key character ist ics of PC:
large number of sellers & buyers
identical products freedom of entry & exit
Impl icat ion (or conclus ion ) Firms in PC cannot earn economic profits in
the long run
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Efficiency
A l locat ive eff ic iency:
Resources are allocated among firms andindustries to obtain a mix of products
most desired by society (consumers)
Product ive eff ic iency:
The least costly methods of productionare used (ie. goods are produced at thelowest possible costs)
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Efficiency and PerfectCompetition
Priceof product X = the relative worth ofproduct X to the society (or the marginal
benefit/satisfaction the society gets from anadditional unit of X) .
Marginal Costof product X is the cost ofproducing an additional unit of X
(MC measures the sacrifice of other goods inusing resources to produce more of X)
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Efficiency and PerfectCompetition
A l locat ive eff ic iency: P > MC : resources are under allocated
P < MC : resources are over allocated
P = MC : resources are best allocated/utilised
Product ive eff ic iency: P = min ATC
(For more details, read Jackson pp. 276 77)
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Assessment of Perfect Competition
Pros
Productive efficiency: min AC (ie. firms produceat the least-cost output)
Allocative efficiency: P = MC
Consumer gains from low prices (ie. maximumconsumer surplus) Speed of resource reallocation No power groups
Cons
Less scope for R&D Almost no product variety
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Short-Run Supply Curve
For the individual firm: the SR supplycurve is the MC curve above the AVCcurve
For the entire industry: horizontal sum offirms MC curves above AVC
P MC Sh t R S l C
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P = MC: Short-Run Supply Curve
P
Q
MC
AVC
ATC
Cost
sand
reven
ues(dollar
s)
At every price, theMR = MC point
changes the quantitybeing exchanged...
P MC Sh t R S l C
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P = MC: Short-Run Supply CurveP
Q
MC
AVC
ATC
Cos
tsand
revenues(dollars)
MR3Record the
quantity being
supplied foreach price
Q3
P3
P MC Sh t R S l C
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P = MC: Short-Run Supply CurveP
Q
MC
AVC
ATC
Costsand
revenues(dollars)
MR3
Q3
MR2At a lower pricea lower quantity
will be supplied
Q2
P2
P3
P MC Sh t R S l C
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P = MC: Short-Run Supply CurveP
Q
MC
AVC
ATC
Costsand
revenues(dollars)
MR3
Q3
MR2
Q2
P2
P3
At a higher pricea greater quantitywill be supplied
Q4
Break-even
(no rmal prof i t )
po in t
MR4P4
P = MC: Short Run Supply Curve
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P = MC: Short-Run Supply CurveP
Q
MC
AVC
ATC
Costsand
revenues(dollars)
MR3
Q3
MR2
Q2
P2
P3
Q4
Break-even
(no rmal prof i t )
po in t
MR4
Q5
MR5P
4
P5
P = MC: Short Run Supply Curve
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P = MC: Short-Run Supply CurveP
Q
MC
AVC
ATC
Costsand
revenues(dollars)
MR3
Q3
MR2
Q2
P2
P3
Q4
Break-even
(no rmal prof i t )
po in t
MR4
Q5
MR5P
4
P5
MR1P1 Firm should notproduce unless
revenue is at leastable to meet AVC
P = MC: Short Run Supply Curve
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P = MC: Short-Run Supply CurveP
Q
MC
AVC
ATC
Costsand
revenues(dollars)
MR3
Q3
MR2
Q2
P2
P3
Q4
Break-even
(no rmal prof i t )
po in t
MR4
Q5
MR5P
4
P5
MR1P1The Marginal
Cost Curve at points aboveAVC represents the short-run
supply curve
P = MC: Short Run Supply Curve
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P = MC: Short-Run Supply CurveP
Q
MC
AVC
ATC
Costsand
revenues(dollars)
MR3
Q3
MR2
Q2
P2
P3
Q4
MR4
Q5
MR5P
4
P5
MR1P1
Short-run
supp ly curve
(red)
P = MC: Short Run Supply Curve
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P = MC: Short-Run Supply Curve
P
Q
MC1
AVC1
If costs increase...the supply curveeffectively shiftsto the left
MC2
AVC2
P = MC: Short Run Supply Curve
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P = MC: Short-Run Supply Curve
P
Q
MC2
AVC2
MC1
AVC1
If costs decrease...the supply curveeffectively shiftsto the right