1. Perfect Competition - Final

2. Objectives Investigate firms’ costs under perfect competition Explain the meaning and implication of shut down point Discuss why is perfect competition is economically efficient Review milk essay structure Conduct a self assessment to help revision

3. Feedback on homework - Steel Anderton p329 Add these marks to the Q’s – to give you an idea of quantity required in answers…. Q1 = 4 Q2 = 10 Q3 = 6

4. Many small firms each of whom produces an insignificant percentage of total market output and thus exercise no control over the market price P Q O D SP Q O P = D = AR Price takers…so small and so many – individual firms cannot influence price The firm’s demand curve is perfectly e l a s t i c because any firm that raises its prices sees demand fall to zero as consumers, with perfect knowledge, switch to other producers offering an identical product for a better price IndustryFirm

5. Long run equilibrium P Q O D SP Q O P = D = AR = MR IndustryFirm P1 Q1 MC AC MR=MC Maximum profits Before we look at the market dynamics, lets first understand what the end state looks like…

6. To what extent does the dairy market reflect the characteristics of Perfect Competition? It’s your lucky day! Two of you to come up and run through your structures on the board

7. It’s your lucky day!

8. Shut down point

9. First a bit of practice on your basics.. I will show you a series of slides and will ask a person to read and complete the sentence…

10. Profit-Maximizing Level of Output The goal of the firm is to _____________ __________. When it decides what quantity to produce it continually asks how changes in quantity affect ____________.

11. Profit-Maximizing Level of Output The goal of the firm is to maximize profits. When it decides what quantity to produce it continually asks how changes in quantity affect profit.

12. Profit-Maximizing Level of Output Since profit is the difference between _____ _________ and _____ ____, what happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC). A firm maximizes profit when __ = __.

13. Profit-Maximizing Level of Output Since profit is the difference between total revenue and total cost, what happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC). A firm maximizes profit when MC = MR.

14. Profit-Maximizing Level of Output _______ ________ (__) – the change in total revenue associated with a change in quantity. _______ ____ (__) -- the change in total cost associated with a change in quantity.

15. Marginal Revenue Since a perfect competitor accepts the market price as given, for a competitive firm, marginal revenue is _____ ( __ = _).

16. Marginal Revenue Since a perfect competitor accepts the market price as given, for a competitive firm, marginal revenue is price (MR = P).

17. Marginal Cost Initially, marginal cost _____ and then begins to _____. Marginal concepts are best defined between the numbers.

18. Marginal Cost Initially, marginal cost falls and then begins to rise. Marginal concepts are best defined between the numbers.

19. How to Maximize Profit To maximize profits, a firm should produce where _______ ______ equals _______ ________.

20. How to Maximize Profit To maximize profits, a firm should produce where marginal cost equals marginal revenue.

21. How to Maximize Profit If marginal revenue does not equal marginal cost, a firm can increase profit by changing _______. The supplier will continue to produce as long as _______ _______ is less than _______ _______.

22. How to Maximize Profit If marginal revenue does not equal marginal cost, a firm can increase profit by changing output. The supplier will continue to produce as long as marginal cost is less than marginal revenue.

23. How to Maximize Profit The supplier will cut back on production if _______ ________ is greater than _______ ________. Thus, the profit-maximizing condition of a competitive firm is __ = __ = _.

24. How to Maximize Profit The supplier will cut back on production if marginal cost is greater than marginal revenue. Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.

25. C A P = D = MR Costs 12345678910Quantity 60 50 40 30 20 10 0 A B MC Marginal Cost, Marginal Revenue, and Price 0 1 2 3 4 5 6 7 8 9 10 £28.00 20.00 16.00 14.00 12.00 17.00 22.00 30.00 40.00 54.00 68.00 Price = MR Quantity Produced Marginal Cost £35.00 35.00

26. The Marginal Cost Curve Is the Supply Curve The marginal cost curve is the firm's supply curve above the point where price exceeds average variable cost.

27. The Marginal Cost Curve Is the Supply Curve The MC curve tells the competitive firm how much it should produce at a given price. The firm can do no better than producing the quantity at which marginal cost equals price which in turn equals marginal revenue.

28. The Marginal Cost Curve Is the Firm’s Supply Curve A B C Marginal cost Cost, Price £70 60 50 40 30 20 10 0 1Quantity2345678910

29. Shut down point

30. Profit / Loss (£mln) PeriodTotal VCTotal FCTotal Costs Total Revenue If production takes place If plant is shut down 130205060+10-20 2302050 0-20 330205040-10-20 430205030-20 530205020-30-20 Trading situation getting worse Still making a profit - carry on trading Break-even (includes ‘normal profit’ Making a loss but not as bad as if plant shut down Making a loss equal to loss plant shut down Cheaper for the company to shut down

31. The Shutdown Point The firm will shut down if it cannot cover average variable costs.  A firm should continue to produce as long as price is greater than average variable cost.  Once price falls below that point it makes sense to shut down temporarily and save the variable costs.

32. The Shutdown Point The shutdown point is the point at which the firm will gain more by shutting down than it will by staying in business.

33. The Shutdown Point As long as total revenue is more than total variable cost, temporarily producing at a loss is the firm’s best strategy since it is taking less of a loss than it would by shutting down.

34. Once price falls below this point it makes sense to shut down temporarily and save the variable costs MC P = MR Quantity Price 0 ATC AVC Loss The Shutdown Decision Market price is lower that ATC. Hence the firm is making a loss Firm should continue to produce as long as price is greater than average variable cost. Profit maximisation MR = MC

35. What does Michael O’Leary think?

36. Homework review: Label the diagram

37. Is Perfect Competition economically efficient?

38. Efficiency Put together a definition of “efficiency” in your own words Now define what you understand by the term “productive efficiency” Now define what you understand by the term “allocative efficiency” Whiteboards

39. Productive efficiency Attained when a firm…  operates at minimum average total cost  Choosing an appropriate combination of inputs (cost efficiency)  Producing the maximum output possible from those inputs (technical efficiency) P Q O Q1 AC The best resource mix! To attain productive efficiency, both technical AND cost efficiency need to be achieved In the LONG run!

40. Allocative efficiency Achieved when society is producing an appropriate bundle of goods relative to consumer preferences Firms can be productively efficient producing loads of stuff nobody wants! Under Perfect Competition the ‘Consumer is King’ and ultimately determine which resources are used to produce which goods and services Allocative efficiency is achieved when the marginal benefit to society is equal to the marginal cost, -i-in other words where price is set equal to marginal cost In both the SHORT and the LONG run

41. Dynamic Efficiency Dynamic efficiency occurs over time. (as opposed to Productive and Allocative which are at a point in time – static efficiency) It focuses on changes in the consumer choice available in a market together with the quality / performance of goods and services that we buy Dynamic efficiency: We assume that a perfectly competitive market produces homogeneous products – in other words, there is little scope for innovation designed to make products differentiated from each other and thereby allow a supplier to develop and then exploit a competitive advantage in the market to establish some monopoly power. This is to do with the rate o investment…would it be better if the firm invested money over time rather than distribute profits?

42. Now tell me, are Perfectly Competitive markets economically efficient? You have 5 mins to dig out the article I gave you and put together your case using a diagram

43. Benefits of PC Lower prices  Large number of competing firms  High elastic demand curve Low barriers to entry  New firms enter and keep prices low Greater entrepreneurial activity  In SR entrepreneurs strive for profit – finding ways to outdo other businesses Economic efficiency  competition will ensure that firms attempt to minimise their costs and move towards productive efficiency  The threat of competition should lead to a faster rate of technological diffusion as firms have to be particularly responsive to the changing needs of consumers….dynamic efficiency.

44. Homework Complete worksheet on Perfect Competition for Monday Oct 10

45. Plenary Analyse diagrammatically the behaviour of firms in a PC market structure Recap on how to answer questions and recognising trigger words Investigate firms’ costs under perfect competition Explain the meaning and implication of shut down point