Chapter 8 Perfect Competition ECONOMICS: Principles and Applications, 4e HALL & LIEBERMAN, © 2008 Thomson South-Western

2 Market structure The characteristics of a market that influence how trading takes place 1.How many buyers and sellers? 2.Products: standardized or significantly different? 3.Barriers to entry/exit ?

3 Market structure Types of markets –Perfect competition –Monopoly –Monopolistic competition –Oligopoly

4 Perfect Competition Many buyers and sellers –no individual decision maker can significantly affect the price of the product Standardized product –buyers do not perceive differences between the products Sellers can easily enter/exit the market –no significant barriers to discourage new entrants

5 Is Perfect Competition Realistic? Many markets - while not strictly perfectly competitive - come reasonably close Perfect competition can approximate conditions and yield accurate-enough predictions in a wide variety of markets

6 The Competitive Firm’s Demand Curve Horizontal demand curve – perfectly elastic - at the market price Output is standardized Price taker –The price of its output is given Decision –How much output to produce and sell

7 The Competitive Firm’s Demand Curve D S Ounces of Gold per Day Price per Ounce MarketFirm Ounces of Gold per Day Price per Ounce $400 1.The intersection of the market supply and the market demand curve… $400 3.The typical firm can sell all it wants at the market price… 2.determines the equilibrium market price Demand Curve Facing the Firm 4.so it faces a horizontal demand curve. Figure 1 The Competitive Industry and Firm

8 Cost and Revenue Data Marginal revenue curve –The demand curve facing the firm –A horizontal line at the market price

9 Profit Maximization TR 550 $2,800 2,100 TC Slope = 400 Ounces of Gold per Day Dollars Profit = TR-TC Maximum Profit per Day = $700 Figure 2 Profit Maximization in Perfect Competition (a) TR-TC

10 Profit Maximization MC $400 d = MR Ounces of Gold per Day Dollars Figure 2 Profit Maximization in Perfect Competition (b) MR=MC Profit maximization MR=MC

11 Profit Maximization Total Profit = TR – TC MR>MC – increase output Maximize profit: MR=MC Measuring Total Profit –Profit per unit = P – ATC If P > ATC – the firm earns profit If P < ATC – the firm suffers a loss

12 Measuring Profit or Loss Ounces of Gold per Day Dollars MC ATC $400 d = MR Figure 3 Measuring Profit or Loss a) Economic Profit Total profit = profit per unit *Q 300 Profit per unit=revenue per unit - cost per unit Profit per Ounce ($100) MR=MC Q=7

13 Measuring Profit or Loss MC ATC d = MR $ Loss per unit= cost per unit - revenue per unit Loss per Ounce ($100) Ounces of Gold per Day Dollars Figure 3 Measuring Profit or Loss b) Economic Loss MR=MC Q=5 Total loss = loss per unit *Q

14 The Firm’s Short-Run Supply Curve The firm –takes the market price as given –decides how much output to produce at that price Profit-maximizing output level: P=MC –As price of output changes, firm will slide along its MC curve in deciding how much to produce –Exception – If the firm is suffering a loss large enough to justify shutting down

15 The Firm’s Short-Run Supply Curve ,000 2,000 4,000 5,000 7, $ MC ATC d 1 =MR 1 AVC (a) Firm's Supply Curve ,0004,000 5,000 7, $ (b) d 2 =MR 2 d 3 =MR 3 d 4 =MR 4 d 5 =MR 5 Bushels per Year Dollars Price per Bushel Bushels per Year Figure 4 Short-Run Supply Under Perfect Competition

16 The Shutdown Price Price at which a firm is indifferent between producing and shutting down If P>AVC – produce If P<AVC – shut down Firm’s supply curve –Is its MC curve for all prices above AVC, and a vertical line at zero units for all prices below AVC.

17 Competitive Markets in the Short- Run Fixed number of firms in industry Market supply curve –Quantity of output - all sellers in a market will produce at different prices –Add up the quantities of output supplied by all firms in the market at each price

18 Competitive Markets in the Short- Run $ Market Supply Curve 200, , , ,000 Firm's Supply Curve ,0004,000 5,000 7, $ At each price... 3.The total supplied by all firms at different prices is the market supply curve. Firm Market Bushels per Year Price per Bushel Bushels per Year 2.the typical firm supplies the profit-maximizing quantity. Figure 5 Deriving The Market Supply Curve

19 Short-Run Equilibrium Competitive firms can e arn economic profit, or suffer an economic loss The market –sums buying and selling preferences of individual consumers and producers, and determines market price Each buyer and seller –Takes market price as given –Is able to buy or sell the desired quantity

20 Perfect Competition Quantity Demanded at Different Prices Quantity Supplied at Different Prices Individual Demand Curve Individual Supply Curve Quantity Demanded by All Consumers at Different Prices Quantity Supplied by All Firms at Different Prices Market Demand Curve Market Supply Curve Quantity Supplied by Each Firm Quantity Demanded by Each Consumer P S D Q Market Equilibrium Added together Figure 6 Perfect Competition

21 Perfect Competition 400,000700, $3.50 S D1D1 D2D2 MC d1d1 d2d2 ATC 7,0004, $ If the demand curve shifts to D 2 and the market equilibrium moves here the typical firm operates here, earning economic profit in the short run. 1.When the demand curve is D 1 and market equilibrium is here... Profit per Bushel at p = $3.50 Price per Bushel Market Bushels per Year Dollars Firm Bushels per Year Loss per Bushel at p = $2 4.the typical firm operates here and suffers a short-run loss. Figure 7 Short-Run Equilibrium in Perfect Competition