8 Perfect Competition SLIDES CREATED BY ERIC CHIANG CHAPTER 8 SLIDE 1 RADIUS IMAGES/ALAMY CHAPTER 8 SLIDE 1

CHAPTER OBJECTIVES Name the primary market structures and describe their characteristics. Define a perfectly competitive market and the assumptions that underlie it. Determine a competitive firm’s profit maximizing quantity and price. Analyze the conditions for profit maximization, loss minimization, and plant shutdown for a firm.  CHAPTER 8 SLIDE 2

CHAPTER OBJECTIVES Derive the firm’s short-run supply curve. Use the short-run competitive model to determine market entry and exit in achieving long-run equilibrium. Describe why competition is in the public interest. CHAPTER 8 SLIDE 3

Market structure depends on: MARKET STRUCTURE ANALYSIS By observing a few industry characteristics, we can predict pricing and output behavior. Market structure depends on: number of firms. nature of product. barriers to entry. control over price. CHAPTER 8 SLIDE 4

MONOPOLISTIC COMPETITION PRIMARY MARKET STRUCTURES PERFECT COMPETITION MONOPOLISTIC COMPETITION OLIGOPOLY MONOPOLY CHAPTER 8 SLIDE 5

THE CORN AND WHEAT INDUSTRIES ARE EXAMPLES OF PERFECT COMPETITION. AGSTOCK IMAGES, INC./ALAMY THE CORN AND WHEAT INDUSTRIES ARE EXAMPLES OF PERFECT COMPETITION. CHAPTER 8 SLIDE 6

Characteristics of perfect competition include: many buyers and sellers. homogeneous (standardized) products. no barriers to market entry or exit. no long-run economic profit. no control over price. CHAPTER 8 SLIDE 7

THE RESTAURANT INDUSTRY IS AN EXAMPLE OF MONOPOLISTIC COMPETITION EASTPHOTO/AGE FOTOSTOCK THE RESTAURANT INDUSTRY IS AN EXAMPLE OF MONOPOLISTIC COMPETITION CHAPTER 8 SLIDE 8

Characteristics of monopolistic competition include: many buyers and sellers. differentiated products. little to no barriers to market entry or exit. no long-run economic profit. some control over price. CHAPTER 8 SLIDE 9

THE AUTOMOBILE INDUSTRY IS AN OLIGOPOLY CHRISTOPHER HONEYWELL/ALAMY THE AUTOMOBILE INDUSTRY IS AN OLIGOPOLY CHAPTER 8 SLIDE 10

Characteristics of oligopoly include: relatively few firms. interdependent decision making. substantial barriers to market entry. potential long-run economic profit. shared market power. considerable control over price. CHAPTER 8 SLIDE 11

THE NATIONAL FOOTBALL LEAGUE IS A MONOPOLY CHRIS CHAMBERS/GETTY IMAGES THE NATIONAL FOOTBALL LEAGUE IS A MONOPOLY CHAPTER 8 SLIDE 12

Characteristics of monopoly include: one firm. no close substitutes for product. nearly insuperable barriers to entry. potential long-run economic profit. substantial market power and control over price. CHAPTER 8 SLIDE 13

In a perfectly competitive market, each firm is a price taker: PERFECTLY COMPETITIVE MARKETS In a perfectly competitive market, each firm is a price taker: Individual firms get their prices from the market because they are so small that they cannot influence the market price. They take the price as given. CHAPTER 8 SLIDE 14

MARGINAL REVENUE = ΔTR / ΔQ THE CHANGE IN TOTAL REVENUE THAT RESULTS FROM THE SALE OF ONE ADDITIONAL UNIT OF A PRODUCT. TOTAL REVENUE = P × Q MARGINAL REVENUE = ΔTR / ΔQ CHAPTER 8 SLIDE 15

VS. FIRM DEMAND CURVE MARKET DEMAND CURVE S PRICE ($) PRICE ($) D = MR 200 200 D = MR D Qe q1 q2 INDUSTRY OUTPUT TYPICAL FIRM’S OUTPUT CHAPTER 8 SLIDE 16

THE PROFIT MAXIMIZATION RULE A FIRM MAXIMIZES PROFIT BY PRODUCING AT THE POINT WHERE MARGINAL REVENUE EQUALS MARGINAL COST (MR = MC). WE FIRST FOCUS ON SHORT-RUN (FIXED PLANT SIZE) PROFIT MAXIMIZATION. CHAPTER 8 SLIDE 17

SHORT-RUN PROFIT MAXIMIZATION 120 MC 100 80 COST D = MR 60 Marginal cost of the 83rd unit is less than MR (relinquishing the normal return from the 84th unit). 40 20 83 84 85 OUTPUT CHAPTER 8 SLIDE 18

COMPETITIVE FIRM EARNING PROFITS 120 MC 100 80 ATC COST D = MR 60 PROFITS AVC 40 Profit = (P − ATC) × Q 20 83 84 85 OUTPUT CHAPTER 8 SLIDE 19

FIVE STEPS TO MAXIMIZING PROFIT Step 1: Find MR = MC 120 MC 100 Step 2: Find optimal Q 80 ATC COST 3 D = MR 1 60 PROFITS 5 AVC Step 3: Find optimal P 4 40 Step 4: Find ATC 20 2 Step 5: Find profit 83 84 85 OUTPUT CHAPTER 8 SLIDE 20

AT LEAST ONE FACTOR OF PRODUCTION (SUCH AS PLANT SIZE) IS FIXED. SHORT RUN VS. LONG RUN SHORT RUN LONG RUN ALL FACTORS ARE VARIABLE. FIRMS ENTER IN RESPONSE TO PROFITS AND EXIT IN RESPONSE TO LOSSES. AT LEAST ONE FACTOR OF PRODUCTION (SUCH AS PLANT SIZE) IS FIXED. CHAPTER 8 SLIDE 21

Normal profits are equal to zero economic profit where P = ATC. 1,200 1,000 MC ATC 800 AVC COST D = MR 600 Normal profits are equal to zero economic profit where P = ATC. 400 200 1 2 3 4 5 6 OUTPUT CHAPTER 8 SLIDE 22

ZERO ECONOMIC PROFIT IN THE LONG RUN A perfectly competitive firm earns zero economic profit in the long run. Remember: zero economic profit (a normal profit) can still be a substantial accounting profit. CHAPTER 8 SLIDE 23

© RICK BARRENTINE/CORBIS LOSS MINIMIZATION: WHEN PRICE < ATC, FIRMS MINIMIZE LOSSES BY PRODUCING IF P > AVC OR SHUT DOWN IF P < AVC. CHAPTER 8 SLIDE 24

COMPETITIVE FIRM WITH LOSSES ATC MC AVC $80 LOSSES COST D = MR 70 Negative profit = (P − ATC) × quantity = (70 − 80) × 35 = −$350 35 OUTPUT CHAPTER 8 SLIDE 25

SHUTDOWN POINTS ATC MC AVC $80 LOSSES COST 70 D = MR 65 When price falls below $65 (minimum point on AVC), losses exceed fixed costs. SHUTDOWN POINT 30 OUTPUT CHAPTER 8 SLIDE 26

SHORT-RUN SUPPLY CURVE MC SHORT-RUN SUPPLY CURVE ATC AVC A firm’s short-run supply curve is its marginal cost curve above the minimum point on the average variable cost curve. COST OUTPUT CHAPTER 8 SLIDE 27

HERBERT SIMON (1916–2001) Argued that firms are not always perfectly rational because they do not have perfect information and do not always strive to maximize profits. Won the Nobel Prize in Economics in 1978. CHAPTER 8 SLIDE 28

If firms take losses, some firms leave the industry. LONG-RUN ADJUSTMENTS If firms earn short-run economic profits, new firms enter the industry and existing firms expand their operations. If firms take losses, some firms leave the industry. Long-run equilibrium occurs where P = MR = MC = LRATCmin. CHAPTER 8 SLIDE 29

ECONOMIC PROFITS ATTRACT ENTRY INDUSTRY FIRM S0 MC PRICE ($) PRICE ($) S1 ATC 20 20 D0 = MR0 PROFITS 15 15 D1 = MR1 D Q0 Q1 q1 q0 INDUSTRY OUTPUT TYPICAL FIRM’S OUTPUT CHAPTER 8 SLIDE 30

ECONOMIC LOSSES LEAD TO EXIT INDUSTRY FIRM S1 S0 MC PRICE ($) PRICE ($) ATC 25 25 D1 = MR1 LOSSES 20 20 D0 = MR0 D Q1 Q0 q0 q1 INDUSTRY OUTPUT TYPICAL FIRM’S OUTPUT CHAPTER 8 SLIDE 31

GOODS ARE SUPPLIED AT THE LOWEST POSSIBLE COST. The long-run outcome in competitive markets exhibit: PRODUCTIVE EFFICIENCY: GOODS ARE SUPPLIED AT THE LOWEST POSSIBLE COST. ALLOCATIVE EFFICIENCY: MIX OF GOODS AND SERVICES IS JUST WHAT SOCIETY DESIRES. CHAPTER 8 SLIDE 32

When an industry expands, how do resource prices change? LONG-RUN INDUSTRY SUPPLY Depends on long-run average total cost (LRATC), which varies according to economies or diseconomies of scale. When an industry expands, how do resource prices change? CHAPTER 8 SLIDE 33

PJRSTUDIO/ALAMY INCREASING-COST INDUSTRY: AS INDUSTRY EXPANDS, DEMAND FOR RAW MATERIALS (SUCH AS PRECIOUS METALS) INCREASES PRICES. CHAPTER 8 SLIDE 34

© CHARLES PERTWEE/CORBIS DECREASING-COST INDUSTRY: AS INDUSTRY EXPANDS, ECONOMIES OF SCALE RESULT IN LOWER PRICES (e.g., COMPUTER CHIPS). CHAPTER 8 SLIDE 35

CONSTANT-COST INDUSTRY: EXPANDS IN THE LONG RUN WITHOUT SIGNIFICANT CHANGES IN COST (e.g., FAST FOOD RESTAURANTS) ERIC CHIANG CHAPTER 8 SLIDE 36

LONG-RUN COMPETITIVE EQUILIBRIUM INDUSTRY FIRM S0 MC LRATC SRATC PRICE PLR PRICE AND COST PLR D0 = MR D QLR qLR INDUSTRY OUTPUT TYPICAL FIRM’S OUTPUT P = MR = MC = SRATCmin= LRATCmin CHAPTER 8 SLIDE 37

INCREASING-, CONSTANT-, OR DECREASING-COST INDUSTRY INCREASING COSTS CONSTANT COSTS DECREASING COSTS S0 S0 S0 b S1 b S1 SLR b S1 c a c PRICE PRICE PRICE SLR a a c D1 D1 D0 SLR D0 D1 D0 OUTPUT OUTPUT OUTPUT CHAPTER 8 SLIDE 38

KEY CONCEPTS Market structure analysis Perfect competition Price taker Marginal revenue Profit-maximization rule Normal profits Shutdown point Short-run supply curve Increasing cost industry Decreasing cost industry Constant cost industry KEY CONCEPTS CHAPTER 8 SLIDE 39

WHICH OF THE FOLLOWING IS LIKELY TO BE THE MOST COMPETITIVE? CABLE TELEVISION A AUTOMOBILES AND TRUCKS B OIL REFINING C Answer: E INTERNATIONAL AIR TRAVEL D FARM COMMODITIES E CHAPTER 8 SLIDE 40

EPA EUROPEAN PRESSPHOTO AGENCY CREATIVE ACCOUNT/ALAMY PRACTICE QUESTION IF THE MARGINAL REVENUE OF TEA IS $10 AND MARGINAL COST IS $5, WHY WOULDN’T THIS BE AN OPTIMAL LEVEL OF PRODUCTION? Answer: When MR is greater than MC, a firm can increase profits by producing more. The optimal level of production occurs when MR = MC. CHAPTER 8 SLIDE 41

IF GNOMES-R-US (A COMPETITIVE FIRM) PRODUCES AT THE POINT WHERE MARGINAL COST INTERSECTS THE AVERAGE TOTAL COST CURVE AT ITS MINIMUM POINT, THE FIRM WILL EARN: ECONOMIC PROFITS. A NORMAL PROFITS. B Answer: B A SHORT-RUN LOSS. C NO PROFITS AT ALL. D CHAPTER 8 SLIDE 42

AP PHOTO/JEFF BARNARD, FILE PRACTICE QUESTION Answer: If producers enter a competitive market, prices will fall, assuming that the demand does not significantly rise as a result of the change in law. AS MORE STATES LEGALIZE MARIJUANA PRODUCTION, WHAT WILL HAPPEN TO THE MARKET PRICE? CHAPTER 8 SLIDE 43

SHOULD A COMPETITIVE FIRM KEEP PRODUCING EVEN IF IT FACES SHORT-RUN LOSSES? YES, BECAUSE IT IS EARNING NORMAL PROFITS. A YES, AS LONG AS IT IS COVERING ITS VARIABLE COST. B NO, A FIRM SHOULD NEVER INCUR LOSSES. C Answer: B NO, BECAUSE IT IS NOT COVERING ITS FIXED COST. D CHAPTER 8 SLIDE 44

8 END OF CHAPTER SLIDES CREATED BY ERIC CHIANG CHAPTER 8 SLIDE 45 Tshooter/Shutterstock; Anton Balazh/Shutterstock CHAPTER 8 SLIDE 45