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 CompetitionThe Three Requirements for Perfect Competition Is Perfect Competition Realistic?Is Perfect Competition Realistic?

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 ConstraintsGoals and Constraints Cost and Revenue DataCost and Revenue Data Finding the Profit-Maximizing Output LevelFinding the Profit-Maximizing Output Level Measuring Total ProfitMeasuring Total Profit The Firm’s Short-Run Supply CurveThe Firm’s Short-Run Supply Curve

The Perfectly Competitive Firm Faces a cost constraint like any other firmFaces 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 inputsCost 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 a a a Ounces of Gold per Day Price per Ounce $400 D S (a) Market Price per Ounce Ounces of Gold per Day Demand Curve Facing the Firm $400 (b) Firm

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

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 ApproachTotal Revenue and Total Cost Approach Marginal Revenue and Marginal Cost ApproachMarginal Revenue and Marginal Cost Approach

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

Measuring Profit or Loss Ounces of Gold per Day Dollars $ Profit per Ounce $100 d = MR MC ATC (a) Economic Profit Ounces of Gold per Day Dollars MC ATC d = MR $ Loss per Ounce $100 (b) Economic Loss

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

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 CurveThe (Short-Run) Market Supply Curve Short-Run EquilibriumShort-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 aaa $ (a) Firm Market Supply Curve Bushels per Year Price per Bushel 200, , , ,000 (b) Market Firm’s Supply Curve Bushels per Year Price per Bushel ,0004,000 5,000 7, $

Short-Run Equilibrium aaa a Bushels per Year Price per Bushel 400,000700, $3.50 S D 1 D 2 (a) Market MC d 2 Loss per Bushel at p = $2 7,0004,000Bushels per Year Dollars 2.00 $3.50 d 1 (b) Firm ATC Profit per Bushel at p = $3.50

Competitive Markets in the Long Run Profit and Loss and the Long RunProfit and Loss and the Long Run Long-Run EquilibriumLong-Run Equilibrium The Notion of Zero Profit in Perfect CompetitionThe Notion of Zero Profit in Perfect Competition Perfect Competition and Plant SizePerfect Competition and Plant Size A Summary of the Competitive Firm in the Long RunA Summary of the Competitive Firm in the Long Run

Competitive Markets in the Long Run Economic profit and loss are the forces driving long-run changeEconomic profit and loss are the forces driving long-run change Expectation of continued economic profit causes outsiders to enter the marketExpectation of continued economic profit causes outsiders to enter the market Expectation of continued economic losses causes firms in the market to exitExpectation 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 $ S 1 (a)

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

Competitive Markets in the Long Run (c)

Competitive Markets in the Long Run A d 1 d 2 Bushels per Year 5,0009, $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 a a Output per Period Dollars P 1 (a) q 1 d 1 = MR 1 1 ATC 1 MC Dollars (b) Output per Period d 2 = MR 2 ATC 2 MC 2 LRATC P * q * E

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 DemandA Change in Demand Market Signals and the EconomyMarket Signals and the Economy

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

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

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.

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

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