Microeconomics ECON 2302 Spring 2010 Marilyn Spencer, Ph.D. Professor of Economics Chapter 11

Reviewing Learning Objectives from Chapter 10. You should be able to: Define technology and give examples of positive and negative technological change. Distinguish between the economic short run and the economic long run. Understand the relationship between the marginal product of labor and the average product of labor. Explain and illustrate the relationship between marginal cost and average total cost. Graph average total cost, average variable cost, average fixed cost, and marginal cost. Understand how firms use the long-run average cost curve to plan.

Any questions on these topics? Anything else?

Chapter 11. Firms in Perfectly Competitive Markets

Explain how a perfect competitor decides how much to produce. The process of competition is at the heart of the market system and is the focus of this chapter. After studying this chapter, you should be able to: Define a perfectly competitive market, and explain why a perfect competitor faces a horizontal demand curve. Explain how a perfect competitor decides how much to produce. Use graphs to show a firm’s profit or loss. Explain why firms may shut down temporarily. Explain how entry and exit ensure that firms earn zero economic profit in the long run. Explain how perfect competition leads to economic efficiency. 1 2 LEARNING OBJECTIVES 3 4 5 6

Firms in Perfectly Competitive Markets 11 – 1 The Four Market Structures MARKET STRUCTURE CHARACTERISTIC PERFECT COMPETITION MONOPOLISTIC COMPETITION OLIGOPOLY MONOPOLY Number of firms Type of product Ease of entry Examples of industries Many Identical High Wheat Apples Differentiated Selling DVDs Restaurants Few Identical or differentiated Low Manufacturing computers Manufacturing automobiles One Unique Entry blocked First-class mail delivery Tap water

Perfectly Competitive Markets LEARNING OBJECTIVE 1 Perfectly Competitive Markets Perfectly competitive market A market that meets the conditions of: many buyers and sellers, all firms selling identical products, no barriers to new firms entering the market perfect information – or at least very low cost to information access

Perfectly Competitive Markets A Perfectly Competitive Firm Cannot Affect the Market Price Price taker A buyer or seller that is unable to affect the market price. 11 - 1 A Perfectly Competitive Firm Faces a Horizontal Demand Curve

Perfectly Competitive Market Profit Total revenue minus total cost. LEARNING OBJECTIVE 2 How a Firm Maximizes Profit in a Perfectly Competitive Market Profit Total revenue minus total cost. Profit = TR - TC

Don’t Confuse the Demand Curve for Farmer Douglas’s Wheat with the Market Demand Curve for Wheat The Market Demand for Wheat versus the Demand for One Farmer’s Wheat 11 - 2

How a Firm Maximizes Profit in a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market Average revenue (AR) Total revenue divided by the number of units sold. Marginal revenue (MR) Change in total revenue from selling one more unit.

How a Firm Maximizes Profit in a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market Farmer Douglas’s Revenue from Wheat Farming 11 – 2 NUMBER OF BUSHELS (Q) MARKET PRICE (PER BUSHEL) (P) TOTAL REVENUE (TR) AVERAGE REVENUE (AR) MARGINAL REVENUE (MR) 1 2 3 4 5 6 7 8 9 10 $4 $0 12 16 20 24 28 32 36 40 -

How a Firm Maximizes Profit in a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market 11 –3 Farmer Douglas’s Profits from Wheat Farming QUANTITY (BUSHELS) (Q) TOTAL REVENUE (TR) TOTAL COSTS (TC) PROFIT (TR-TC) MARGINAL REVENUE (MR) MARGINAL COST (MC) 1 2 3 4 5 6 7 8 9 10 $0.00 4.00 8.00 12.00 16.00 20.00 24.00 28.00 32.00 36.00 40.00 $1.00 6.00 7.50 9.50 15.00 19.50 25.50 32.50 40.50 -$1.00 0.00 2.00 4.50 6.50 9.00 8.50 3.50 -0.50 $4.00 $3.00 1.50 2.50 3.00 7.00

How a Firm Maximizes Profit in a Perfectly Competitive Market 11 - 3 The Profit-Maximizing Level of Output Can you explain why there’s a difference between MR & MC at the profit maximizing quantity in this graph???

Illustrating Profit or Loss on the Cost Curve Graph LEARNING OBJECTIVE 3 Illustrating Profit or Loss on the Cost Curve Graph Profit = (P x Q)  TC Or Profit = (P  ATC)Q

Illustrating Profit or Loss on the Cost Curve Graph 11 - 4 The Area of Maximum Profit

Determining Profit-Maximizing Price and Quantity 11-1 LEARNING OBJECTIVE 3 Determining Profit-Maximizing Price and Quantity OUTPUT PER DAY TOTAL COST MARGINAL COST 1 2 3 4 5 6 7 8 9 $1.00 1.50 1.75 2.25 3.00 4.00 5.25 6.75 8.50 10.50 - $0.50 0.25 0.50 0.75 1.00 1.25 2.00

Illustrating Profit or Loss on the Cost Curve Graph Illustrating When a Firm Is Breaking Even or Operating at a Loss: P > ATC, which means the firm makes a profit P = ATC, which means the firm breaks even (its total cost equals it total revenue) P < ATC, which means the firm experiences losses

Illustrating Profit or Loss on the Cost Curve Graph 11 - 5 A Firm Breaking Even and Experiencing Losses

Illustrating Profit or Loss on the Cost Curve Graph Remember that Firms Maximize Total Profit, Not Profit per Unit:

Losing Money in the Medical Screening Industry 11 - 1 Losing Money in the Medical Screening Industry Providing preventive medical scans turned out not to be a profitable business. What type of medical announcement might change this?

Deciding Whether to Produce or to Shut Down in the Short Run LEARNING OBJECTIVE 4 Deciding Whether to Produce or to Shut Down in the Short Run In the short run a firm suffering losses has two choices: Continue to produce Stop production by shutting down temporarily Sunk cost A cost that has already been paid and that cannot be recovered.

Deciding Whether to Produce or to Shut Down in the Short Run: The Supply Curve of the Firm in the Short Run The Firm’s Short-Run Supply Curve 11 - 6 Shutdown point: Minimum point on firm’s average variable cost curve; if the price falls below this point, the firm shuts down in the short run.

11 - 2 When to Close a Laundry Keeping a business open even when suffering losses can sometimes be the best decision in the short run.

The Entry and Exit of Firms in the Long Run LEARNING OBJECTIVE 5 The Entry and Exit of Firms in the Long Run Remember the conditions of a perfectly competitive market: many buyers and sellers, all firms selling identical products, no barriers to new firms entering the market perfect information – or at least very low cost to information access

The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision 11 - 7 Firm Supply and Market Supply

The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision Economic profit A firm’s revenues minus all its costs, implicit and explicit. Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs.

The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision: 11 – 5 Farmer Appleseed’s Costs per Year EXPLICIT COSTS Water Wages Organic fertilizer Electricity Payment on bank loan $25,000 $35,000 $14,000 $5,000 $6,000 IMPLICIT COSTS Foregone salary Opportunity cost of the $100,000 she has invested in her farm Total Cost $30,000 $10,000 $125,000

The Entry and Exit of Firms in the Long Run ECONOMIC PROFIT LEADS TO ENTRY OF NEW FIRMS 11 - 8 The Effect of Entry on Economic Profits

The Entry and Exit of Firms in the Long Run ECONOMIC LOSSES LEAD TO EXIT OF FIRMS 11 - 9 The Effect of Exit on Economic Losses

The Entry and Exit of Firms in the Long Run ECONOMIC LOSSES LEAD TO EXIT OF FIRMS 11 -9 The Effect of Exit on Economic Losses (cont’d.)

The Entry and Exit of Firms in the Long Run Long-Run Equilibrium in a Perfectly Competitive Market Long-run competitive equilibrium The situation in which the entry and exit of firms have resulted in the typical firm just breaking even.

The Decline of Apple Production in New York State 11 - 3 The Decline of Apple Production in New York State When apple growers in New York State stopped breaking even, many sold their land to housing developers.

Perfect Competition and Efficiency LEARNING OBJECTIVE 6 Productive Efficiency Productive efficiency The situation in which a good or service is produced at the lowest possible cost.

How Productive Efficiency Benefits Consumers 11-2 LEARNING OBJECTIVE 6 How Productive Efficiency Benefits Consumers

Perfect Competition and Efficiency Allocative Efficiency Allocative efficiency A state of the economy in which production reflects consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

Perfect Competition and Efficiency Allocative Efficiency means in the market: Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them: The price of a good represents the marginal benefit consumers receive from consuming the last unit sold. Perfectly competitive firms produce up to the point where the price equals the marginal cost of producing the last unit. Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. MB = MC

Organic Food Trend Chips Out a Niche in Snack Food Isle

Allocative efficiency Average revenue (AR) Economic loss Economic profit Long-run supply curve Marginal revenue Perfectly competitive market Price taker Productive efficiency Profit Shutdown point Sunk cost

Assignments for March 23: Pre-read Ch. 12, including: Review Questions: p. 432, 1.1 – 1.3; p. 436, 4.1 & 4.2; p. 438, 6.1 & 6.2 (1st edition: 1, 2, 3, 7 8 & 10 on pp. 406-407); and Problems and Applications: p. 432, 1.4; p. 433, 2.5; p. 435, 3.3; & p. 4.34, 2.11 (1st edition: 1, 3, 5 & 17 on pp. 407-410).