1. Chapter 14 Perfectly competitive Market

2. But first lets look at this

3. Profit Maximization

4. Profit Maximization
This occurs where marginal revenue (MR) = marginal cost (MC).
MR = MC
Marginal revenue is the extra revenue earned when one additional unit is produced
The MC curve is also the firms supply curve

5. Profit Maximization Outcomes
If MC < MR, the firm should increase output
If MC > MR, the firm should decrease output
If Price > ATC, the firm makes profit
If Price < ATC, the firm makes losses
If Price = ATC, the firm earns zero profit (normal profit)

6. The market price is always $6.
Quantity
Total Revenue
Total Cost
Profit
Marginal Revenue
Marginal Cost $3 - 1 5 2 8 3 12 4 17 23 6 30 7 38 47

8. Review: Key Concepts for Competitive Markets
Market price = MR and AR
Profit maximization occurs where MR = MC
If MR > MC, the firm should increase output
If MR < MC, the firm should decrease output
If where MR = MC is above ATC = firm makes profit
If where MR = MC is below ATC = firm makes losses
The MC curve is also the firms supply curve

9. Market Structures Competitive Markets OLIGOPOLY
MONOPOLISTIC COMPETITION
MONOPOLY

10. What is a market structure?
The way consumers and producers are organized in a market
Amount of firms?
Variety of goods?
Control over prices?
Barriers to entry?

11. How many firms are in the market?

12. Variety of goods
How different are the goods in the market?

13. Control over prices
How much control does a firm have over their prices?

14. Competitive Markets (Perfect Competition)
Chapter 14

15. What does this have to do with competition?

16. Do you think economists would consider this a competitive market?

17. What are competitive markets?
Main conditions that must be met:
Many buyers and sellers
Goods offered are identical or largely the same
Consumers have complete control over price
Firms can freely enter and exit the market

18. Economists sometimes call competitive markets perfect competition
Economists sometimes call competitive markets perfect competition. So, whether you hear a firm is in a competitive market or in a perfectly competitive market, it is the same thing!

19. There are very few markets that compete perfectly
The market for wheat is a competitive market. This is because there are many buyers and sellers of wheat AND all wheat is largely identical.

20. Most markets are not perfectly competitive, but very close.
The burger market is close to perfectly competitive because there are many buyers and sellers, but the product they sell is NOT identical. So, these firms are monopolistically competitive.

21. Monopolistic Competition
Firms that produce differentiated products.
Products in a particular market that are slightly different than one another

22. We’ll talk more about monopolistic competition in chapter 17!

23. So which market do you think buyers have more control over price?

24. The perfectly competitive firm

25. If Joe the farmer sells wheat for $5 a bushel, then I’ll just go buy wheat from Bob instead who sells it for $4 a bushel. What do I care? All wheat is the same so I just want the cheapest price!

26. Price Takers
Firms that are competing in a perfectly competitive market are the “price takers.”
The firms have no control over price, so the only thing they can control is how much they produce.
They must charge the market price

27. Nike has SOME control over the price of sweaters because they can offer a slightly different version than their competitors.

28. Joe the farmer has NO control over prices because his wheat is exactly the same as his competitors. So if he raises the price of his wheat, the customers will buy from his competitors instead. Therefore, Joe the farmer is a price taker.

29. Political Cartoon Contest
Think of a market that is monopolistically competitive. (Products have some differences)
Draw a political cartoon of what that market would look like if it was perfectly competitive.
Make it unique and eye catching
Creativity and humor definitely helps
Using popular figures also helps dramatically
The top three will be chosen by my best friends
Then, the class will vote for the best cartoon in the class

31. Firms shut down vs. exit decision

32. Firm Activity Question?
You run a drive in movie theater. In the month of November, if you stayed open it would cost you $150 to operate your theater. In that month, you would earn $100 in revenue. Your fixed cost is $100.
How much profit/loss if you stayed open during November?
How much profit/loss if you shut down during November?
Shut Down= loss of $100
Stay Open = loss of $50
Because in the SHORT RUN there are still fixed costs to pay, it is rational to stay open in the short run because less money is lost.

33. What does shut down mean?
Shutting down is a short-run decision not to produce anything for a specific period of time
When firms decide to close down forever and leave the market, that is called an exit.
Most golf courses shut down in the winter.
In 2011, Borders exited the book market.

34. The Supply Curve (MC) for a Firm
Short-Run Supply Curve
The portion of its marginal cost curve that lies above average variable cost.
Firm compares price to AVC
Long-Run Supply Curve
The marginal cost curve above the minimum point of its average total cost curve.
Firm compares price to ATC

35. Long run supply curve starts here
Costs
and
Revenue
Long run supply curve starts here MC
ATC
AVC
Quantity
Short run supply curve starts here

36. Lets analyze a firm’s cost and revenue graph to understand the shut down decision

37. At what market price(s) will this firm have guaranteed profit?
Optimal P4 P3 Q3 Q4
Optimal
P1 and P2

38. At what market price(s) will this firm have guaranteed losses?
Optimal P4 P3 Q3 Q4
Optimal
P3 and P4

39. If market price was at P4, should the firm shut down?
Optimal P4 P3 Q3 Q4
Optimal
NO!

40. Shutting Down
If Price > or equal to AVC, the firm does not shut down
If Price < AVC, the firm does shut down

41. At P4, the MR is greater than AVC
At P4, the MR is greater than AVC. That means the quantity produced at P4 will cover all of the firm’s variable costs plus some of its fixed costs.
Optimal P4 P3 Q3 Q4
Optimal
So, this is better than shutting down and having to pay all of the firm’s fixed costs

42. If market price was P3, should the firm shut down?
Optimal P4 P3 Q3 Q4
Optimal
Yes!

43. At P3, the MR is less than AVC
At P3, the MR is less than AVC. That means the quantity produced at P3 will not cover all of the firm’s variable costs.
Optimal P4 P3 Q3 Q4
Optimal
So, the firm won’t be able to cover its variable costs and even its fixed costs. Shut down!

44. Review: Shut Down Key Concepts
The short run supply curve is the portion of the MC curve that lies above AVC.
The shut down decision only happens when a firm is comparing revenue to AVC.
If Price > AVC, the firm does not shut down
If Price < AVC, the firm does shut down

45. sh
Questions?
Optimal P4 P3 Q3 Q4
Optimal

46. The firms long run decision to exit the market

47. So firms compare revenue to ATC when making long run decisions.
Remember, the long run supply curve starts at the MC curve above the minimum point of ATC curve
Long run supply curve starts here
Costs MC
ATC
Quantity
So firms compare revenue to ATC when making long run decisions.

48. The rules of long run decisions
When Price < ATC, the firm exits the market
When Price > ATC, new firms enter the market

49. If market price was P1, the firm should exit the market because the revenue does not cover the total costs. MC
Costs P3
ATC P2 P1 Q1 Q2 Q3
Quantity

50. If market price was P3, more firms will enter the market because the revenue not only covers the costs, but earns profit for the firm. MC
Costs P3
ATC P2 P1 Q1 Q2 Q3
Quantity

51. What would happen if market price was P2?MC
Costs P3
ATC P2 P1 Q1 Q2 Q3
Quantity

52. If market price was P2, no firms would exit or enter the market
If market price was P2, no firms would exit or enter the market. This is because profits in this market have been driven to zero. MC
Costs P3
ATC P2 P1 Q1 Q2 Q3
Quantity

53. Competitive Markets in the Long Run
Oh, please be good to me invisible hand 

54. Competitive Markets in the Long Run
In the long run, Price = ATC
Firms earn zero profit (normal).
Firms will enter or exit the market until profit is driven to zero.
The long-run market supply curve is perfectly elastic at this price (horizontal).

55. So lets look at Joe the farmer’s competitive corn market

56. The beginning days the energy shot
(a) Initial Condition
Market
Firm
Price
Price
ATC MC S
Short-run supply, 1 D
Demand, 1 1 Q A
Long-run
supply P 1 P 1
Quantity (market)
Quantity (firm)
The corn market began in long run equilibrium…
And Joe’s farm (the firm) earned zero profit.

57. Then, teens start to get hooked on corn
An increase in market demand…
The higher P encourages firms to produce more…
…raises price and output.
…and generates short-run profit.
(b) Short-Run Response
Market
Firm
Price
Price D 2 S 1
ATC MC Q 2 P B D 1 P 2 Q 1 A
Long-run
supply P1 P 1
Quantity (market)
Quantity (firm)

58. New firms enter the corn market
Profits induce entry and market supply increases.
(c) Long-Run Response
Market
Firm
Price
Price D 2 S1
ATC B MC P2 S 2 A Q 3 C
Long-run
supply P 1 P 1 D1 Q1 Q2
Quantity (market)
Quantity (firm)
The increase in supply lowers market price.
In the long run market price is restored, but market supply is greater.

59. We are now back on long run equilibrium
In the short run, I made profit and produced more. But, in the long run, I’m back to making zero profit (normal) and I even have more competitors!