The Story of Pure Competition The Green Bean Market Perfection: Most Efficient (3 Ways) production economic allocation of scarce resources The most output, at the least cost, with no shortages and surplus or mis-allocation of valuable resources.

Characteristics of a Perfectly Competitive Market Structure Assumptions that affect the behaviors of the firm Many small firms who by themselves do not affect the industry All firms produce an identical product Consumers and all firms know that the products are identical and what price is: Total knowledge Firms can enter and exit easily because they are small and have little invested

Results for every firm Price taker No market power Most efficient: Produces at of long run ATC

The Demand Curve for Green Bean Producers The interaction of market supply and demand yields an equilibrium price of $5 and quantity of 25,000 units Neither an individual buyer or seller can influence the price 10,00020,00030,00040,00050,000 S D 0 Green Beans

The Demand Curve of the Perfect Competitor The perfectly competitive firm: –Is a price taker (i.e., must sell for $5) –Will sell all units for $5 –Will sell zero units if it wants a higher price –Cannot sell more units at a lower price

Industry and the firm side by side Explain why Price=d 10,00020,00030,00040,00050,000 Industry S D 0 Green Beans Individual firm 0 Green Beans 5 E d 5

How Much Should the Perfect Competitor Produce? Explain why P=d=AR The firm will produce the level of output that will maximize profits given the market price. Total Revenues –The price per unit times the total quantity sold Price X Quantity Economic profit = total revenue (TR) - total cost (TC)

How Much Should the Perfect Competitor Produce? P determined by the market in perfect competition Q determined by the producer to maximize profit Now Why Price=d=AR=MR=MC TR = P x Q Average revenue (AR)  TR Q PQ Q   P P Economic profit = total revenue (TR) - total cost (TC)

How Much Should the Perfect Competitor Produce? TC  explicit  opportunity cost Economic profit = total revenue (TR) - total cost (TC)

Profit Maximization Figure 23-3, Panel (a)

Profit Maximization Where TR-TC is the greatest Total Output/ Sales/TotalMarketTotalTotal dayCostsPriceRevenueProfit Figure 23-3, Panel (b) 0$10$5$0  $      1

How Much Should the Perfect Competitor Produce? Therefore Profit-maximizing rate of production –Firm sets production where it can maximizes total profits –Which is where –the difference between total revenues and total costs is the greatest TR-TC= greatest –the rate of production at which marginal revenue equals marginal cost MC=MR

Profit Maximization TR-TC= greatest matches where MR=MC Figure 23-3, Panel (c) Total Output/ Sales/MarketMarginalMarginal dayPriceCostRevenue 0$ $

Marginal revenue (MR)  ∆TR ∆output Marginal cost (MC)  ∆TC ∆output Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production

Left side of graph MR > MC TR is increasing more than TC and profits are increasing as you increase output MR > MC

Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production MR > MC MC > MR Right side of graph MC > MR TC is increasing more than TR profits are decreasing.

Profit Maximization Total Output/ Sales/TotalMarketTotalTotalMarginalMarginal dayCostsPriceRevenueProfitCostRevenue 0$10$5$0  $      1 MR > MC MR = MC MR < MC $

Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production We have proven why you produce at MR=MC Profit maximization—a review –TR  TC= greatest –And this matches to where –at the unit that MC = MR For a perfectly competitive firm, –Price =d=AR=MR and now its marginal cost curve

Short-Run Profits Minidisks per Day P = MR = AR MC ATC d Profits Profit is maximized where MR = MC ATC = TC/output TC = ATC  output TR = P  output Profit = (P - ATC)  output Figure 23-4

Short-Run Profits P = MR = AR MC ATC d Profits At P = $5, ATC = 4.33 Output = 7.5 units TR = $5 ´ 7.5 = 37.5 TC = $4.33 ´ 7.5 = 32.5 Profit = = $5 or ($ ) ´ 7.5 = $5

Losses OK if Price above AVC Price and Cost per Unit ($) P = MR = AR MC ATC d1d1 Losses d2d2 Losses are minimized where MR = MC Loss = ($ )  5.5 or $7.43

Loss Minimization of Short- Run Profits P = MR = AR MC ATC d1d1 Losses d2d2

Therefore Short-Run Firm will operate in SR Where Price=d=ar=mr=mc at or above AVC make economic profits or economic losses.

Short-Run Shutdown and Break-Even Price Short-run break-even point If Price goes below AVC Short-run shutdown point

Short-Run Break-Even Price –The price at which a firm’s total revenues equal its costs –At the break-even price, the firm is just making a normal rate of return on its capital investment Short-Run Shutdown Price –The price that just covers average variable costs: Cheaper to shut down and just pay FC –It occurs just below the intersection of the marginal cost curve and the average variable cost curve

The Meaning of Zero Economic Profits –Distinguish between economic profits and accounting profits –When economic profits are zero, accounting profits are positive –Normal profits and zero economic profits because you are paying your bills and paying yourself

The Perfect Competitor’s Short-Run Supply Curve the firm’s supply curve is the marginal cost curve above the short-run shutdown point. Or MC above min. of AVC –in a competitive industry is its marginal costs curve equal to and above the point of intersection with the average variable cost curve.

The Individual Firm’s Short-Run Supply Curve Given the price, the quantity is determined where MC = MR Short-run supply = MC above minimum AVC

The Perfect Competition Industry ALL FIRMS Short-Run Supply Curve Factors that influence the industry supply curve (determinants of supply): NON PRICE DETERMINANTS For the individual firm---if it effects costs then the supply curve or MC will shift up if costs go up and down if costs go down –Firm’s productivity –Factor costs –Taxes and subsidies

The Perfect Competitors Industry Short-Run Supply Curve all firms production at a certain price Figure 23-8, Panels (a), (b), and (c)

Therefore the Supply curve for the Industry –The market supply curve is equal to the horizontal summation of the portions of the individual marginal cost curves above their respective minimum average variable costs –ADD ALL THE MC’s output at a price for all the firms –Supply curve is the Sum of all MC’s =>AVC

Competitive Price Determination P e is the price the firm must take

The Long-Run Industry Situation: Look at all the factors that the firm uses Produce at one point only where MR=MC at the min. of LRATC If above this point: clear profit will cause new firms to enter the industry---therefore supply shifts to the right and price automatically comes down. adjustment If below LRATC then firm exit the industry==goes out of business adjustment

Therefore in the long run Profits and losses act as signals for resources to enter an industry or to leave an industry. Clear profit==enter Loses =exit

The Adjustment Graphically cool S D Quantity of Wheat (industry) Quantity of Wheat (firm) Break-even MC ATC qeqe

A European crop failure increases the demand for U.S. wheat Higher price creates economic profit European crop failure increases the Demand for U.S. wheat S1S1 D1D1 Quantity of Wheat (industry) Quantity of Wheat (firm) Q1Q1 q1q1 MC ATC q2q2 D2D2

New firms enter to get those profits: new lower price S1S1 D1D1 Quantity of Wheat (industry) Quantity of Wheat (firm) P1P1 Q1Q1 q1q1 MC ATC D2D2 S2S2 Second thing to heppen-----Economic profit attracts new firms In the industry prices fall the firm takes the new lower price Price fall to break-even

The Adjustment Graphically: oh no loses, and exit What will happen to supply What happens if for some firms prices fall too low Reaction to losses S D Quantity of Wheat (industry) Price of Wheat ($) Quantity of Wheat (firm) d = MR PePe QeQe MC ATC qeqe

The Adjustment Graphically S1S1 D Quantity of Wheat (industry) Price of Wheat ($) d = MR Quantity of Wheat (firm) P1P1 Q1Q1 q1q1 Break-even MC ATC Losses signal for resources to leave the market Supply falls and price increases to break-even S2S2 P2P2

The Long-Run Industry Situation: Exit and Entry Summary –Economic profits Signal resources to enter the market and the price falls to the break-even price –Economic losses Signal resources to exit the market and the price increases to the break-even level

The Long-Run Industry Situation: Exit and Entry Summary –At break-even Resources will not enter or exit because the market is yielding a normal rate of return –In the long run, the perfectly competitive firms will make zero economic profits (normal rate of return)

The Long-Run Industry Situation: Exit and Entry Long-Run Industry Supply Curve –A market supply curve showing the relationship between price and quantities –after firms have been allowed time to enter or exit from an industry –For individual firms it is one point at min of ATC where MC=MR

Different types of Industries Constant-Cost Industry –An industry whose total output can be increased without an increase in long-run per-unit costs Decreasing-Cost Industry –An industry in which an increase in industry output leads to a reduction in long-run per unit costs Increasing-Cost Industry –An industry in which an increase in industry output is accompanied by an increase in long-run per unit costs

Marginal Cost Pricing –A system of pricing in which the price charged is equal to the opportunity cost to society of producing one more unit of the good or service in question –Without externality or market failure

Marginal cost Pricing eliminates failures or corrects them If too much of a product is produced that is harmful to society Problem that too many resources are being used to produce something harmful Price too low and consumers are buy the bad Correction tax the producers You are shifting the supply curve up ---MC

Marginal Cost Pricing to correct problem Too little is being produced at too high a price to consumers--this is something that society might benefit from –Too few resources are being used –Price too high –Correction subsidize the consumers --shift demand or subsidize the producers Analyze the consequences