Microeconomics ECON 2302 May 2011 Marilyn Spencer, Ph.D. Professor of Economics Chapter 11

Announcement: 2 nd Bonus Quiz 5 points possible Announcement: 2 nd Bonus Quiz 5 points possible  View the film, “Informant!”  Send an that explains who in the US is caught for collusion and what consequences they face.  this (approx. 100 words) to before class, May 26.  I think you can still find this film online by going to: K# and clicking on “free user,” then closing the pop-up window. Then click on “play now” on the right hand side. K#

CHAPTER 11 Firms in Perfectly Competitive Markets The market for organically grown food has expanded rapidly in the United States.

11.1Perfectly Competitive Market Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. 11.2How a Firm Maximizes Profit in a Perfectly Competitive Market. Explain how a firm maximizes profit in a perfectly competitive market. 11.3Illustrating Profit or Loss on the Cost Curve Graph Use graphs to show a firm’s profit or loss. CHAPTER 11 Chapter Outline and Six (6)Learning Objectives Firms in Perfectly Competitive Markets

11.4Deciding Whether to Produce or to Shut Down in the Short Run Explain why firms may shut down temporarily. 11.5“If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.6Perfect Competition and Efficiency Explain how perfect competition leads to economic efficiency. Chapter Outline and 6 Learning Objectives, cont. Firms in Perfectly Competitive Markets

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

Perfectly competitive market A market that meets these conditions: 1. Many buyers and sellers 2.Identical products 3.No barriers to new firms entering the market and no barriers to firms choosing to leave the market 4.Very low cost information Price taker A buyer or seller that is unable to affect the market price. A Perfectly Competitive Firm Cannot Affect the Market Price! Perfectly Competitive Markets Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve LEARNING OBJECTIVE

FIGURE 11-1 A Perfectly Competitive Firm Faces a Horizontal Demand Curve The Demand Curve for the Output of a Perfectly Competitive Firm A firm in a perfectly competitive market is selling exactly the same product as many other firms. Thus, it can sell as much as it wants at the current market price, but it cannot sell anything at all if it raises the price by even 1 cent. As a result, the demand curve for a perfectly competitive firm’s output is a horizontal line. In the figure, whether the wheat farmer sells 6,000 bushels per year or 15,000 bushels has no effect on the market price of $4. Perfectly Competitive Markets

FIGURE 11-2 The Market Demand for Wheat versus the Demand for One Farmer’s Wheat The Demand Curve for the Output of a Perfectly Competitive Firm In a perfectly competitive market, P is determined by the intersection of market D and market S. In panel (a), the D and S curves for wheat intersect at a P of $4 per bushel. An individual wheat farmer like Farmer Parker cannot affect the market P for wheat. Therefore, as panel (b) shows, the D curve for Farmer Parker’s wheat is a horizontal line. Don’t Let This Happen to YOU! Don’t Confuse the D Curve for Farmer Parker’s Wheat with the Market D Curve for Wheat! Perfectly Competitive Markets:

How a Firm Maximizes Profit in a Perfectly Competitive Market Profit Total revenue minus total cost. Profit = TR – TC Revenue for a Firm in a Perfectly Competitive Market Average revenue (AR) Total revenue divided by the quantity of the product sold. Marginal revenue (MR) The change in total revenue from selling one more unit of a product. Explain how a firm maximizes profit in a perfectly competitive market LEARNING OBJECTIVE

NUMBER OF BUSHELS (Q) MARKET PRICE (PER BUSHEL) (P) TOTAL REVENUE (TR) AVERAGE REVENUE (AR) MARGINAL REVENUE (MR) $4 4 $ $4 4 - $4 4 Table 11-2 Farmer Parker’s Revenue from Wheat Farming Revenue for a Firm in a Perfectly Competitive Market How a Firm Maximizes Profit in a Perfectly Competitive Market

QUANTITY (BUSHELS) (Q) TOTAL REVENUE (TR) TOTAL COST (TC) PROFIT (TR-TC) MARGINAL REVENUE (MR) MARGINAL COST (MC) $ $ $ — $ — $ Determining the Profit-Maximizing Level of Output Table 11-3 Farmer Parker’s Profits from Wheat Farming How a Firm Maximizes Profit in a Perfectly Competitive Market

FIGURE 11-3 The Profit-Maximizing Level of Output In panel (a), Farmer Parker maximizes his profit where the vertical distance between TR and TC is the largest. Panel (b) shows that Farmer Parker’s MR is equal to a constant $4/bushel. Farmer Parker maximizes profits by producing wheat up to the point where MR of the last bushel produced is equal to its MC. How a Firm Max’es  in a Perfectly Competitive Market: Determining the Profit-Maximizing Level of Output

1.The profit-maximizing level of output is where the difference between total revenue and total cost is the greatest. 2.The profit-maximizing level of output is also where marginal revenue equals marginal cost, or MR = MC. From the information in Table 11-3 and Figure 11-3, we can draw the following conclusions: How a Firm Max’es  in a Perfectly Competitive Market: Determining the Profit-Maximizing Level of Output

Illustrating Profit or Loss on the Cost Curve Graph Profit = (P x Q)  TC Profit = (P  ATC) x Q or Use graphs to show a firm’s profit or loss LEARNING OBJECTIVE

Showing a Profit on the Graph FIGURE 11-4 The Area of Maximum Profit Illustrating Profit or Loss on the Cost Curve Graph A firm maximizes  at the level of Q at which MR = MC. The difference between P and ATC equals  /unit of Q. Total  equals  /unit multiplied by the number of units produced. Total p is represented by the area of the green- shaded rectangle, which has a height equal to (P - ATC) and a width equal to Q.

Solved Problem 11-3 Determining Profit-Maximizing Price and Quantity OUTPUT PER DAY TOTAL COST 0$

Don’t Let This Happen to YOU! Remember That Firms Maximize Their Total Profits, Not Their Profits per Unit Illustrating Profit or Loss on the Cost Curve Graph

1. P > ATC, which means the firm makes a profit. 2. P = ATC, which means the firm breaks even (its total cost equals its total revenue). 3. P < ATC, which means the firm experiences losses. Illustrating When a Firm Is Breaking Even or Operating at a Loss Illustrating Profit or Loss on the Cost Curve Graph

FIGURE 11-5 A Firm Breaking Even and a Firm Experiencing Losses Illustrating When a Firm Is Breaking Even or Operating at a Loss In panel (b), P is below ATC, and the firm experiences a loss. The loss is represented by the area of the red-shaded rectangle, which has a height equal to (ATC - P) and a width equal to Q. In panel (a), P equals ATC, and the firm breaks even because its TR will be equal to its TC. In this situation, the firm makes zero economic profit.

Losing Money in the Medical Screening Industry Making the Connection

Deciding Whether to Produce or to Shut Down in the Short Run 1.Continue to produce 2.Stop production by shutting down temporarily Sunk cost A cost that has already been paid and that cannot be recovered. In the short run, a firm experiencing losses has two choices: Explain why firms may shut down temporarily LEARNING OBJECTIVE

When to Close a Laundry Making the Connection Keeping a business open even when suffering losses can sometimes be the best decision for an entrepreneur in the short run.

Deciding Whether to Produce or to Shut Down in the Short Run Shutdown point The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run. The Supply Curve of a Firm in the Short Run Total revenue < Variable cost, (P × Q) < VC P < AVC or, in symbols: If we divide both sides by Q, we have the result that the firm will shut down if: Explain why firms may shut down temporarily LEARNING OBJECTIVE

FIGURE 11-6 The Firm’s Short-Run Supply Curve The Supply Curve of a Firm in the Short Run For any given P, we can determine the Q of output the firm will supply from the MC curve. In other words, the MC curve is the firm’s supply curve. The firm will shut down if the price falls below average variable cost. The marginal cost curve crosses the average variable cost at the firm’s shutdown point. This point occurs at output level QSD. For prices below PMIN, the S curve is a vertical line along the P axis, which shows that the firm will supply zero output at those prices. The red line in the figure is the firm’s short-run S curve. Deciding Whether to Produce or to Shut Down in the Short Run

FIGURE 11-7 Firm Supply and Market Supply The Market Supply Curve in a Perfectly Competitive Industry In panel (a), one wheat farmer is willing to supply 15,000 bushels of wheat at a P of $4/bu. Panel (b): If every wheat farmer supplies the same amount of wheat at this P and if there are 167,000 wheat farmers, the total amount of wheat supplied at a price of $4 will equal 15,000 bushels/farmer × 167,000 farmers = 2.5 billion bushels of wheat. We can derive the market S curve by adding up the Q that each firm in the market is willing to supply at each P.

“If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run EXPLICIT COSTS Water Wages Organic fertilizer Electricity Payment on bank loan $10,000 $15,000 $10,000 $5,000 $45,000 IMPLICIT COSTS Foregone salary Opportunity cost of the $100,000 she has invested in her farm $30,000 $10,000 Total cost$125,000 Economic Profit and the Entry or Exit Decision Table Farmer Moreno’s Costs per Year Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run LEARNING OBJECTIVE

Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs. Long-Run Equilibrium in a Perfectly Competitive Market: Long-run competitive equilibrium The situation in which the entry and exit of firms has resulted in the typical firm breaking even – in terms of economic costs. Economic Losses Lead to Exit of Firms Economic profit A firm’s revenues minus all its costs, implicit and explicit. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run

Economic Profit Leads to Entry of New Firms FIGURE 11-8 The Effect of Entry on Economic Profits “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run: Economic Profit and the Entry or Exit Decision

FIGURE 11-9 The Effect of Exit on Economic Losses Economic Losses Lead to Exit of Firms “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run: Economic Profit and the Entry or Exit Decision

FIGURE 11-9 The Effect of Exit on Economic Losses, cont. Economic Losses Lead to Exit of Firms “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run: Economic Profit and the Entry or Exit Decision

Easy Entry Makes the Long Run Pretty Short in the Apple iPhone Apps Store Making the Connection Economic profits are rapidly competed away in the iPhone apps store. In a competitive market, earning an economic profit in the long run is extremely difficult. And the ease of entering the market for iPhone apps has made the long run pretty short.

Perfect Competition and Efficiency Productive efficiency The situation in which a good or service is produced at the lowest possible cost. Productive Efficiency Explain how perfect competition leads to economic efficiency LEARNING OBJECTIVE

How Productive Efficiency Benefits Consumers Solved Problem 11-6 In the long run, firms only break even on their investment in producing high-technology goods. That result implies that investors in these firms are also unlikely to earn an economic profit in the long run.

Allocative Efficiency Perfect Competition and Efficiency Allocative efficiency A state of the economy in which production represents 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.

1.The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. 2.Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit. 3.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. Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them. Perfect Competition and Efficiency: Allocative Efficiency

AN INSIDE LOOK Figure 1 The D for a product increases after it is “green certified.” The graph assumes that the firm did not spend money to acquire certification for its product. It Isn’t Easy - or Cheap - to Be Green >> Figure 2 The D for a product increases after it is “green certified.” The marginal cost and average total cost curves shift up due to the cost of certification.

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

Pre-read Ch. 12 before we start going over it in class, including:  Review Questions: 3 rd ed. p. 422, 1.1—1.3; p. 426, 4.1, 4.2; p. 6.1, 6.2 (2 nd ed., p. 432, 1.1 – 1.3; p. 436, 4.1 & 4.2; p. 438, 6.1 & 6.2; 1 st edition: 1, 2, 3, 7 8 & 10 on pp ); and  Problems and Applications: 3 rd ed. p ; p 423, 2.5; p424, 2.11; p 425, 3.3 (2 nd ed., p. 432, 1.4; p. 433, 2.5; p. 435, 3.3; & p. 4.34, 2.11; 1 st edition: 1, 3, 5 & 17 on pp ).