Introduction to Perfect Competition Micro: Econ: 22 58 Module Introduction to Perfect Competition   KRUGMAN'S MICROECONOMICS for AP* Margaret Ray and David Anderson

What you will learn in this Module: How can weak firms get the profit- maximizing quantity of output? How can we assess whether or not a competitive firm is profitable? The purpose of this module is to introduce the model of perfect competition. Of the four market structures introduced in the previous module, this is the only one in which firms have no control of the price. The price is set in the market and price-taking firms produce the output that maximizes economic profit.

a) Calculate accounting profit b) Calculate MR and MC Qs TR TC 4 32 5 40 33 6 48 34 7 56 36 8 64 39 9 72 44 10 80 51 11 88 60 If students were confused by Module 53, this is an excellent opportunity to review the optimal output rule for maximizing profit.

Profit Maximization in PC Optimal output rule [dojo point] produce the quantity where MR=MC and profit will be maximized! If students were confused by Module 53, this is an excellent opportunity to review the optimal output rule for maximizing profit.

Production and Profits Firms are price-takers P = MR MR = AR, so this tells us about the level of demand – this is what people are willing to pay When the firm is a price taker, AR = PQ/Q = P. Profit maximization occurs at the output level where MC = P Remember “Mr. Darp” In perfect competition, because the firm is a price-taker, each time a unit of output is sold TR rises by the price; thus P=MR in this market structure. There are two other things we should notice about the horizontal P=MR line. -Average revenue (AR) = TR/Q. When the firm is a price taker, AR = PQ/Q = P. -Because the firm cannot raise or lower the price, the horizontal P=MR=AR line also serves as the demand curve for the product. A horizontal demand curve was previously described as “perfectly elastic.” Students can remember these equalities as MR=D=AR= P or “Mr. Darp”. The firm should produce the level of output where MC is equal to the market P.

Profit Maximization in PC The profit maximizing level of output is found where P = MC on the graph. The profit maximizing output level is shown on the horizontal axis of the graph where the upward sloping MC curve crosses the horizontal P = MR = D line.

Calculating Profits Total profit π= TR – TC If TR>TC; positive profit If TR < TC; negative profit Profit per unit If P > ATC; positive profit If P < ATC; negative profit Economic Profit is equal to:   Π = TR – TC Looking at this simple equation we can see that if: TR > TC, Π > 0. TR < TC, Π < 0. TR = TC, Π = 0. Another very useful way to determine if profits are positive or negative is to look at profit on a per-unit, or average basis. Again: To see this on a per-unit basis, divide the profit equation by the number of units Q. Π/Q = TR/Q – TC/Q This tells us that profit per unit is equal to revenue per unit minus cost per unit. Two substitutions to make: Revenue per unit is AR = P. Cost per unit is ATC. One last time: Π/Q = P – ATC P > ATC, Π > 0. P < ATC, Π < 0. P = ATC, Π = 0.

Bad Times and Basic S What happens if TC > TR? What costs does the firm pay? Go back to the table we used before. Graph out the MC curve. What if the market price is 3$, how many does he supply? How about 8$? How about 9$? Economic Profit is equal to:   Π = TR – TC Looking at this simple equation we can see that if: TR > TC, Π > 0. TR < TC, Π < 0. TR = TC, Π = 0. Another very useful way to determine if profits are positive or negative is to look at profit on a per-unit, or average basis. Again: To see this on a per-unit basis, divide the profit equation by the number of units Q. Π/Q = TR/Q – TC/Q This tells us that profit per unit is equal to revenue per unit minus cost per unit. Two substitutions to make: Revenue per unit is AR = P. Cost per unit is ATC. One last time: Π/Q = P – ATC P > ATC, Π > 0. P < ATC, Π < 0. P = ATC, Π = 0.

Can you do it? Helen’s fish farm has an output of 1,000 fish per week. The marginal cost is 30$ per fish, the average variable cost is 20$, and the market price is 25$ a fish. 1) Draw a graph with all three curves. 2) Is she maximizing her profit? 3) If not, does she need to increase or decrease output? Economic Profit is equal to:   Π = TR – TC Looking at this simple equation we can see that if: TR > TC, Π > 0. TR < TC, Π < 0. TR = TC, Π = 0. Another very useful way to determine if profits are positive or negative is to look at profit on a per-unit, or average basis. Again: To see this on a per-unit basis, divide the profit equation by the number of units Q. Π/Q = TR/Q – TC/Q This tells us that profit per unit is equal to revenue per unit minus cost per unit. Two substitutions to make: Revenue per unit is AR = P. Cost per unit is ATC. One last time: Π/Q = P – ATC P > ATC, Π > 0. P < ATC, Π < 0. P = ATC, Π = 0.

Can you do it? Assume maple syrup is a perfectly competitive industry. The market price is 25$ per bottle. To maximize profit, each farm makes 200 bottles a week. Average total cost is 20$ and average variable cost is 15$. The lowest average variable cost is 12$. 1) If the price falls to 20$, will they keep making 200 bottles? Explain. 2) If the price falls to 12$ what will they do? [dojo: What is their profit?] 3) How many do they supply if the market price is a) 25$ b) 12$ c) 10$ Economic Profit is equal to:   Π = TR – TC Looking at this simple equation we can see that if: TR > TC, Π > 0. TR < TC, Π < 0. TR = TC, Π = 0. Another very useful way to determine if profits are positive or negative is to look at profit on a per-unit, or average basis. Again: To see this on a per-unit basis, divide the profit equation by the number of units Q. Π/Q = TR/Q – TC/Q This tells us that profit per unit is equal to revenue per unit minus cost per unit. Two substitutions to make: Revenue per unit is AR = P. Cost per unit is ATC. One last time: Π/Q = P – ATC P > ATC, Π > 0. P < ATC, Π < 0. P = ATC, Π = 0.