Perfect Competition © 2003 South-Western/Thomson Learning

Market Structure All the characteristics of a market than influence the behavior of buyers and sellers Number of buyers and sellers? Standardized products? Barriers to entry or exit?

Market Structure Four basic types of markets: Perfectly competitive Monopolistic Monopolistically competitive Oligopolistic

What Is Perfect Competition? The Three Requirements for Perfect Competition

Three Requirements of Perfect Competition 1. There are large numbers of buyers and sellers, and each buys or sells only a tiny fraction of the total quantity in the market.

Three Requirements of Perfect Competition 2. Sellers offer a standardized product. 3. Sellers can easily enter into or exit from the market.

The Perfectly Competitive Firm Goals and Constraints Cost and Revenue Data Finding the Profit-Maximizing Output Level Measuring Total Profit The Firm’s Short-Run Supply Curve

The Perfectly Competitive Firm Faces a cost constraint like any other firm Cost of producing any given level of output depends on the firm’s production technology and the prices it pays for its inputs

The Competitive Industry and Firm (b) Market Firm Price Price per per Ounce Ounce S D $400 $400 Demand Curve Facing the Firm Ounces of Ounces of Gold per Day Gold per Day a a a

The Perfectly Competitive Firm Price Taker Any firm that treats the price of its product as given and beyond its control.

The Perfectly Competitive Firm Ounces of Gold per Day TR 550 $2,800 2,100 (a) TC Maximum Profit per Day = $700 Dollars MC (b) 1 2 3 4 5 6 7 8 9 10 $400 d = MR Slope = 400

The Perfectly Competitive Firm For a competitive firm, marginal revenue at each quantity is the same as the market price. Thus, the marginal revenue curve and the demand curve facing the firm are the same - a horizontal line at the market price.

Finding the Profit-Maximizing Output Level Total Revenue and Total Cost Approach Marginal Revenue and Marginal Cost Approach

Finding the Profit-Maximizing Output Level Measuring total profit: Profit per unit = P – ATC

Measuring Profit or Loss Ounces of Gold per Day Dollars 1 2 3 4 5 6 7 8 9 10 $400 300 Profit per Ounce $100 d = MR MC ATC (a) Economic Profit Ounces of Gold per Day Dollars MC ATC d = MR $300 200 1 2 3 4 5 6 7 8 9 10 Loss per Ounce $100 (b) Economic Loss

Measuring Profit or Loss A firm earns profit when P>ATC A firm suffers a loss when P<ATC

Short-Run Supply Curve

Short-Run Supply Curve As the price of output changes, the firm will slide along its MC curve in deciding how much to produce.

Short-Run Supply Curve Shutdown Price Price at which a firm is indifferent between producing and shutting down

Firm’s Supply Curve Curve that shows the quantity of output a competitive firm will produce at different prices: For all prices above the minimum point on its AVC curve, the supply curve coincides with the MC curve. For all prices below the minimum point on its AVC curve, the firm will shut down - so its supply curve is a vertical line segment at zero units of output.

Competitive Markets in the Short Run The (Short-Run) Market Supply Curve Short-Run Equilibrium

Competitive Markets in the Short Run Market Supply Curve A curve indicating the quantity of output that all sellers in a market will produce at different prices

The Market Supply Curve (b) Firm Market Price Price per Bushel per Bushel Firm’s Market Supply Supply $3.50 Cu r ve $3.50 Curve 2.50 2.50 2.00 2.00 1.00 1.00 0.50 0.50 2,000 4,000 7,000 Bushels 400,000 700,000 Bushels 5,000 per Year 200,000 500,000 per Year a a a

Short-Run Equilibrium (a) (b) Market Firm Price Dollars D 1 ATC per Bushel S MC $3.50 D 2 $3.50 d 1 Profit per Bushel at p = $3.50 Loss per Bushel at p = $2 2.00 2.00 d 2 400,000 700,000 Bushels 4,000 7,000 Bushels per Year per Year a a a a

Competitive Markets in the Long Run Economic profit and loss are the forces driving long-run change Expectation of continued economic profit causes outsiders to enter the market Expectation of continued economic losses causes firms in the market to exit

Competitive Markets in the Long Run Bushels per Year Price per Bushel S 1 D A 900,000 $4.50 With initial supply curve , market price is $4.50 . . . (a)

Competitive Markets in the Long Run d 1 Bushels per Year Dollars 9,000 $4.50 ATC MC 5,000 . . . so each firm earns an economic profit (b)

Competitive Markets in the Long Run Bushels per Year Price per Bushel 1,200,000 2.50 S 1 D A E 2 900,000 $4.50 Profit attracts entry, shifting the supply curve rightward . . . (c)

Competitive Markets in the Long Run d 1 2 Bushels per Year 5,000 9,000 2.50 $4.50 ATC MC . . . until market price falls to $2.50 and each firm earns zero economic profit (d)

Competitive Markets in the Long Run In a competitive market, positive economic profit continues to attract new entrants until economic profit is reduced to zero.

Competitive Markets in the Long Run In a competitive market, economic losses continue to cause exit until the losses are reduced to zero.

Competitive Markets in the Long Run Normal Profit Another name for zero economic profit

Competitive Markets in the Long Run In long-run equilibrium, every competitive firm will select its plant size and output level so that it operates at the minimum point of its LRATC curve.

Competitive Markets in the Long Run (b) Dollars Dollars LRATC LRATC 1 MC 1 ATC P MC 2 1 d 1 = MR ATC 2 E P * d 2 = MR q 1 Output q * Output per per Period Period a a

Competitive Markets in the Long Run At each competitive firm in long-run equilibrium, P = MC = minimum ATC = minimum LRATC

What Happens When Things Change? A Change in Demand Market Signals and the Economy

A Change in Demand a a INITIAL EQUILIBRIUM (a) Market (b) Firm Price S 1 Dollars MC per D 1 Unit ATC 1 P A P 1 d 1 = MR 1 A Q Output q Output 1 1 per per Period Period NEW EQUILIBRIUM (c) Market (d) Firm Price Dollars per Unit S 1 D 2 MC B S 2 B P D 1 P d SR = MR SR SR S LR ATC 2 C ATC 1 C P P 2 2 d 2 = MR P A P 1 1 d 1 = MR A Q Q Q Output q q q Output 1 SR 2 1 2 SR per per Period Period a a

A Change in Demand Long-run Supply Curve Indicates the quantity of output that all sellers in a market will produce at different prices, after all long-run adjustments have taken place

Increasing Cost Industry A Change in Demand Increasing Cost Industry An industry in which the long-run supply curve slopes upward because each firm’s ATC curve shifts upward as industry output increases

Constant Cost Industry A Change in Demand Constant Cost Industry An industry in which the long-run supply curve is horizontal because each firm’s ATC curve is unaffected by changes in industry output.

Decreasing Cost Industry A Change in Demand Decreasing Cost Industry An industry in which the long-run supply curve slopes downward because each firm’s ATC curve shifts downward as industry output increases

Market Signals and the Economy Price changes that cause firms to change their production to more closely match consumer demand

Technological Change in Perfect Competition (a) Market (b) Firm Price Dollars S 1 per per Bushel Bushel S 2 ATC 1 D A ATC 2 $3 $3 d 1 = MR B 2 2 d 2 = MR Q Q Bushels 1000 Bushels 1 2 per Day per Day a a a