DO NOW!! Think of an industry with… a. 100’s of sellers all selling the exact same thing. b. only 1 major firm c. 100’s of firms, but all with slightly different products d. 2-10 major firms

What are the types of competition? What is “perfect competition”?

4 Types of Competition Perfect (Pure) competition: - large # of firms, identical products Monopoly: 1 firm, unique product Monopolistic Competition: Large # of sellers Slightly differentiated products Oligopoly: few firms

Perfect Competition Large Number of firms (unlimited) Standard, non-differentiated product No barriers to entry (firms may enter or exit the market freely) “Price Taker”: Each firm’s price is decided by the whole market (No single firm has power over market) Ex: wheat farmers, large stock shares…

DO NOW!! If you were a company, how would you choose how much of your good to produce and what price to charge?

P.C. Firm’s Demand Demand is Perfectly Elastic (Flat) Price determined by whole market (normal S and D) [firm is price taker] Total Revenue: All money coming in Average Revenue: TR/Q (= D or P) Marginal Revenue: Ch in TR/Ch in Q For PC firm: MR = D = AR = P * How much should each firm produce?

Short-Run Profit maximization Profit = TR – TC = (P-ATC) x Q To Maximize profit, ALWAYS… Set Q where MR = MC True for all industries at all times*! For Perfectly competitive firms, since P=MR, they set Q where P = MC! Easy to see from graph…

MR=MC Rule P=MR=$100; FC = 100 Total Product AFC AVC ATC TC MC P=MR Econ Profit (TR-TC) ---- _____? 1 100 90 190 -90 2 50 ______? 270 80 ____? -70 3 33.33 113.33 340 4 400 60 5 20 74 94 470 70 30 6 16.67 75 91.67 7 14.29 77.14 91.43 640 8 12.5 81.25 93.75 110

DO NOW!! How do you calculate profit? Why do you think a company might choose to produce its good even if it’s losing money overall?

Short Run Possible Conditions All depends on where P = MC Economic Profit: Intersects above ATC Normal Profit or Breakeven  Intersects at min ATC (MC = ATC) Economic Loss intersects between ATC and AVC Shut down  Intersects at/below min AVC

Economic Profit Set Q where P=MR=MC Economic Profit occurs if point where P=MC is Above ATC *Remember: Profit = (P-ATC) x Q  At that point, (P – ATC) is positive, so Profit is positive! Graph looks like this…

Normal Profit (Break Even) Economic Profit occurs if P=MC point is at Min. of ATC (where MC = ATC)  At this point, (P – ATC) = 0 Graph looks like this…

Economic Loss Economic Loss occurs if P=MC point is between AVC and ATC  Firm still produces because if it doesn’t, it still loses the Fixed Cost and total loss will be greater than if it produces. Graph looks like this…

Shutdown Business will shut down if P=MC point is at min AVC or below Firm loses on a every unit because the variable costs per unit (AVC) are higher than the revenue per unit, so it’s not worth producing at all… Econ Loss = FC S curve is MC above min AVC Graph looks like this…

Summary: Short Run Conditions Here are the 4 situations on one graph…

DO NOW!! If you sold your good for $10, and it cost you $8 to produce each good on average, would you be making a profit?  What might happen if all firms in your industry were making a profit?

Firm vs. Industry Above min AVC, MC curve is the Supply curve Below AVC, Qs = 0. Above AVC, Qs increases as P increases (like S curve) Market S curve is sum of all firms’ MC curves… Graph firm and market side by side…

Perfect Competition: Long Run Firms will enter or exit the market depending on initial SR Condition  Affects market Supply curve… 1. If economic profits in SR, more firms enter the market  S up = P down until econ. profit = 0 (P at Min ATC) 2. If normal profit in SR, nothing changes. (no reason to enter/exit)

Perfect Competition: Long Run 3. If economic loss in SR, firms exit the market  S down, P up until Econ. profit = 0 (P = Min ATC) 4. If shutdown in SR, firms exit the market  S down, P up until Econ. profit = 0 (P = Min ATC)

Long Run Conclusions Market Supply adjusts so P=MC at Min. ATC Firms will earn normal Profits (Economic Profits = 0) Graphs look like this…

SR shifts LR effects Increase in market D  P up  firm D up Econ Profit. In LR, firms enter, S right, P down to Min ATC = Normal Profit Graphs look like this…

Perfect Competition: Efficiency Productive Efficiency: P = Min ATC  Good for consumers b/c producers must be as efficient as possible (higher cost producers suffer economic loss  will exit the market) Allocative Efficiency: P=D=MB=MC P = Marginal Benefit, MB=MC is A.E. If P = MB = MC, then it’s A.E.