Perfect Competition - Final

Objectives Investigate firms’ costs under perfect competition Explain the meaning and implication of shut down point Discuss why is perfect competition is economically efficient Review milk essay structure Conduct a self assessment to help revision

Feedback on homework - Steel Anderton p329 Add these marks to the Q’s – to give you an idea of quantity required in answers…. Q1 = 4 Q2 = 10 Q3 = 6

Two of you to come up and run through your structures on the board To what extent does the dairy market reflect the characteristics of Perfect Competition? Louis Luke Rory Toby Morgan It’s your lucky day! Two of you to come up and run through your structures on the board

Shut down point

First a bit of practice on your basics.. I will show you a series of slides and will ask a person to read and complete the sentence…

Profit-Maximizing Level of Output The goal of the firm is to _____________ __________. When it decides what quantity to produce it continually asks how changes in quantity affect ____________.

Profit-Maximizing Level of Output The goal of the firm is to maximize profits. When it decides what quantity to produce it continually asks how changes in quantity affect profit.

Profit-Maximizing Level of Output Since profit is the difference between _____ _________ and _____ ____, what happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC). A firm maximizes profit when __ = __.

Profit-Maximizing Level of Output Since profit is the difference between total revenue and total cost, what happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC). A firm maximizes profit when MC = MR.

Profit-Maximizing Level of Output _______ ________ (__) – the change in total revenue associated with a change in quantity. _______ ____ (__) -- the change in total cost associated with a change in quantity.

Marginal Revenue Since a perfect competitor accepts the market price as given, for a competitive firm, marginal revenue is _____ ( __ = _).

Marginal Revenue Since a perfect competitor accepts the market price as given, for a competitive firm, marginal revenue is price (MR = P).

Marginal Cost Initially, marginal cost _____ and then begins to _____. Marginal concepts are best defined between the numbers.

Marginal Cost Initially, marginal cost falls and then begins to rise. Marginal concepts are best defined between the numbers.

How to Maximize Profit To maximize profits, a firm should produce where _______ ______ equals _______ ________.

How to Maximize Profit To maximize profits, a firm should produce where marginal cost equals marginal revenue.

How to Maximize Profit If marginal revenue does not equal marginal cost, a firm can increase profit by changing _______. The supplier will continue to produce as long as _______ _______ is less than _______ _______.

How to Maximize Profit If marginal revenue does not equal marginal cost, a firm can increase profit by changing output. The supplier will continue to produce as long as marginal cost is less than marginal revenue.

How to Maximize Profit The supplier will cut back on production if _______ ________ is greater than _______ ________. Thus, the profit-maximizing condition of a competitive firm is __ = __ = _.

How to Maximize Profit The supplier will cut back on production if marginal cost is greater than marginal revenue. Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.

Marginal Cost, Marginal Revenue, and Price MC 1 2 3 4 5 6 7 8 9 10 £28.00 20.00 16.00 14.00 12.00 17.00 22.00 30.00 40.00 54.00 68.00 Price = MR Quantity Produced Marginal Cost £35.00 35.00 Costs 1 2 3 4 5 6 7 8 9 10 Quantity 60 50 40 30 20 C A P = D = MR A B

The Marginal Cost Curve Is the Supply Curve The marginal cost curve is the firm's supply curve above the point where price exceeds average variable cost.

The Marginal Cost Curve Is the Supply Curve The MC curve tells the competitive firm how much it should produce at a given price. The firm can do no better than producing the quantity at which marginal cost equals price which in turn equals marginal revenue.

The Marginal Cost Curve Is the Firm’s Supply Curve Cost, Price £70 60 50 40 30 20 10 1 Quantity 2 3 4 5 6 7 8 9 C A B

Shut down point

Shut down point Profit / Loss (£mln) 1 30 20 50 60 +10 -20 2 3 40 -10 Trading situation getting worse Profit / Loss (£mln) Period Total VC Total FC Total Costs Total Revenue If production takes place If plant is shut down 1 30 20 50 60 +10 -20 2 3 40 -10 4 5 -30 Still making a profit - carry on trading Break-even (includes ‘normal profit’ Making a loss but not as bad as if plant shut down Making a loss equal to loss plant shut down Cheaper for the company to shut down

The Shutdown Point The firm will shut down if it cannot cover average variable costs. A firm should continue to produce as long as price is greater than average variable cost. Once price falls below that point it makes sense to shut down temporarily and save the variable costs.

The Shutdown Point The shutdown point is the point at which the firm will gain more by shutting down than it will by staying in business.

The Shutdown Point As long as total revenue is more than total variable cost, temporarily producing at a loss is the firm’s best strategy since it is taking less of a loss than it would by shutting down.

Market price is lower that ATC. Hence the firm is making a loss The Shutdown Decision Profit maximisation MR = MC MC Price ATC Market price is lower that ATC. Hence the firm is making a loss Loss P = MR Firm should continue to produce as long as price is greater than average variable cost. AVC Once price falls below this point it makes sense to shut down temporarily and save the variable costs Quantity

What does Michael O’Leary think?

Homework review: Label the diagram

Is Perfect Competition economically efficient?

Efficiency Put together a definition of “efficiency” in your own words Whiteboards Put together a definition of “efficiency” in your own words Now define what you understand by the term “productive efficiency” Now define what you understand by the term “allocative efficiency”

Productive efficiency Attained when a firm… operates at minimum average total cost Choosing an appropriate combination of inputs (cost efficiency) Producing the maximum output possible from those inputs (technical efficiency) AC In the LONG run! P The best resource mix! O Q1 Q To attain productive efficiency, both technical AND cost efficiency need to be achieved

Allocative efficiency Achieved when society is producing an appropriate bundle of goods relative to consumer preferences Firms can be productively efficient producing loads of stuff nobody wants! Under Perfect Competition the ‘Consumer is King’ and ultimately determine which resources are used to produce which goods and services Allocative efficiency is achieved when the marginal benefit to society is equal to the marginal cost, in other words where price is set equal to marginal cost In both the SHORT and the LONG run

Dynamic Efficiency This is to do with the rate o investment…would it be better if the firm invested money over time rather than distribute profits? Dynamic efficiency occurs over time. (as opposed to Productive and Allocative which are at a point in time – static efficiency) It focuses on changes in the consumer choice available in a market together with the quality / performance of goods and services that we buy Dynamic efficiency: We assume that a perfectly competitive market produces homogeneous products – in other words, there is little scope for innovation designed to make products differentiated from each other and thereby allow a supplier to develop and then exploit a competitive advantage in the market to establish some monopoly power.

Now tell me, are Perfectly Competitive markets economically efficient? You have 5 mins to dig out the article I gave you and put together your case using a diagram

Benefits of PC Lower prices Low barriers to entry Large number of competing firms High elastic demand curve Low barriers to entry New firms enter and keep prices low Greater entrepreneurial activity In SR entrepreneurs strive for profit – finding ways to outdo other businesses Economic efficiency competition will ensure that firms attempt to minimise their costs and move towards productive efficiency The threat of competition should lead to a faster rate of technological diffusion as firms have to be particularly responsive to the changing needs of consumers….dynamic efficiency.

Homework Complete worksheet on Perfect Competition for Monday Oct 10

Plenary Analyse diagrammatically the behaviour of firms in a PC market structure Recap on how to answer questions and recognising trigger words Investigate firms’ costs under perfect competition Explain the meaning and implication of shut down point