1. Microeconomics ECON 2302 Spring 2010
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 11

2. Reviewing Learning Objectives from Chapter 10. You should be able to:
Define technology and give examples of positive and negative technological change.
Distinguish between the economic short run and the economic long run.
Understand the relationship between the marginal product of labor and the average product of labor.
Explain and illustrate the relationship between marginal cost and average total cost.
Graph average total cost, average variable cost, average fixed cost, and marginal cost.
Understand how firms use the long-run average cost curve to plan.

3. Any questions on these topics?
Anything else?

4. Chapter 11. Firms in Perfectly Competitive Markets

5. Explain how a perfect competitor decides how much to produce.
The process of competition is at the heart of the market system and is the focus of this chapter.
After studying this chapter, you should be able to:
Define a perfectly competitive market, and explain why a perfect competitor faces a horizontal demand curve.
Explain how a perfect competitor decides how much to produce.
Use graphs to show a firm’s profit or loss.
Explain why firms may shut down temporarily.
Explain how entry and exit ensure that firms earn zero economic profit in the long run.
Explain how perfect competition leads to economic efficiency. 1 2
LEARNING OBJECTIVES 3 4 5 6

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

7. Perfectly Competitive Markets
LEARNING OBJECTIVE 1
Perfectly Competitive Markets
Perfectly competitive market A market that meets the conditions of:
many buyers and sellers,
all firms selling identical products,
no barriers to new firms entering the market
perfect information – or at least very low cost to information access

8. Perfectly Competitive Markets
A Perfectly Competitive Firm Cannot Affect the Market Price
Price taker A buyer or seller that is unable to affect the market price.
11 - 1
A Perfectly Competitive Firm Faces a Horizontal Demand Curve

9. Perfectly Competitive Market Profit Total revenue minus total cost.
LEARNING OBJECTIVE 2
How a Firm Maximizes Profit in a
Perfectly Competitive Market
Profit Total revenue minus total cost.
Profit = TR - TC

10. Don’t Confuse the Demand Curve for Farmer Douglas’s Wheat with the Market Demand Curve for Wheat
The Market Demand for Wheat versus the Demand for One Farmer’s Wheat
11 - 2

11. How a Firm Maximizes Profit in a Perfectly Competitive Market
Revenue for a Firm in a Perfectly Competitive Market
Average revenue (AR) Total revenue divided by the number of units sold.
Marginal revenue (MR) Change in total revenue from selling one more unit.

12. How a Firm Maximizes Profit in a Perfectly Competitive Market
Revenue for a Firm in a Perfectly Competitive Market
Farmer Douglas’s Revenue from Wheat Farming
11 – 2
NUMBER OF BUSHELS
(Q)
MARKET PRICE
(PER BUSHEL)
(P)
TOTAL REVENUE
(TR)
AVERAGE REVENUE
(AR)
MARGINAL REVENUE
(MR) 1 2 3 4 5 6 7 8 9 10 $4 $0 12 16 20 24 28 32 36 40 -

13. How a Firm Maximizes Profit in a Perfectly Competitive Market
Revenue for a Firm in a Perfectly Competitive Market
11 –3
Farmer Douglas’s Profits from Wheat Farming
QUANTITY (BUSHELS)
(Q)
TOTAL REVENUE
(TR)
TOTAL COSTS
(TC)
PROFIT
(TR-TC)
MARGINAL REVENUE
(MR)
MARGINAL COST
(MC) 1 2 3 4 5 6 7 8 9 10
$0.00
4.00
8.00
12.00
16.00
20.00
24.00
28.00
32.00
36.00
40.00
$1.00
6.00
7.50
9.50
15.00
19.50
25.50
32.50
40.50
-$1.00
0.00
2.00
4.50
6.50
9.00
8.50
3.50
-0.50
$4.00
$3.00
1.50
2.50
3.00
7.00

14. How a Firm Maximizes Profit in a Perfectly Competitive Market
11 - 3
The Profit-Maximizing Level of Output
Can you explain why there’s a difference between MR & MC at the profit maximizing quantity in this graph???

15. Illustrating Profit or Loss on the Cost Curve Graph
LEARNING OBJECTIVE 3
Illustrating Profit or Loss on the Cost Curve Graph
Profit = (P x Q)  TC Or
Profit = (P  ATC)Q

16. Illustrating Profit or Loss on the Cost Curve Graph
11 - 4
The Area of Maximum Profit

17. Determining Profit-Maximizing Price and Quantity
11-1
LEARNING OBJECTIVE 3
Determining Profit-Maximizing Price and Quantity
OUTPUT PER DAY
TOTAL COST
MARGINAL COST 1 2 3 4 5 6 7 8 9
$1.00
1.50
1.75
2.25
3.00
4.00
5.25
6.75
8.50
10.50 -
$0.50
0.25
0.50
0.75
1.00
1.25
2.00

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

19. Illustrating Profit or Loss on the Cost Curve Graph
11 - 5
A Firm Breaking Even and Experiencing Losses

20. Illustrating Profit or Loss on the Cost Curve Graph
Remember that Firms Maximize Total Profit, Not Profit per Unit:

21. Losing Money in the Medical Screening Industry
11 - 1
Losing Money in the Medical Screening Industry
Providing preventive medical scans turned out not to be a profitable business.
What type of medical announcement might change this?

22. Deciding Whether to Produce or to Shut Down in the Short Run
LEARNING OBJECTIVE 4
Deciding Whether to Produce or to Shut Down in the Short Run
In the short run a firm suffering losses has two choices:
Continue to produce
Stop production by shutting down temporarily
Sunk cost A cost that has already been paid and that cannot be recovered.

23. Deciding Whether to Produce or to Shut Down in the Short Run:
The Supply Curve of the Firm in the Short Run
The Firm’s Short-Run Supply Curve
11 - 6
Shutdown point: Minimum point on firm’s average variable cost curve; if the price falls below this point, the firm shuts down in the short run.

24. 11 - 2
When to Close a Laundry
Keeping a business open even when suffering losses can sometimes be the best decision in the short run.

25. The Entry and Exit of Firms in the Long Run
LEARNING OBJECTIVE 5
The Entry and Exit of Firms in the Long Run
Remember the conditions of a perfectly competitive market:
many buyers and sellers,
all firms selling identical products,
no barriers to new firms entering the market
perfect information – or at least very low cost to information access

26. The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
11 - 7
Firm Supply and Market Supply

27. The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
Economic profit A firm’s revenues minus all its costs, implicit and explicit.
Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs.

28. The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision:
11 – 5
Farmer Appleseed’s Costs per Year
EXPLICIT COSTS
Water
Wages
Organic fertilizer
Electricity
Payment on bank loan
$25,000
$35,000
$14,000
$5,000
$6,000
IMPLICIT COSTS
Foregone salary
Opportunity cost of the $100,000 she has invested in her farm
Total Cost
$30,000
$10,000
$125,000

29. The Entry and Exit of Firms in the Long Run
ECONOMIC PROFIT LEADS TO ENTRY OF NEW FIRMS
11 - 8
The Effect of Entry on Economic Profits

30. The Entry and Exit of Firms in the Long Run
ECONOMIC LOSSES LEAD TO EXIT OF FIRMS
11 - 9
The Effect of Exit on Economic Losses

31. The Entry and Exit of Firms in the Long Run
ECONOMIC LOSSES LEAD TO EXIT OF FIRMS
11 -9
The Effect of Exit on Economic Losses (cont’d.)

32. The Entry and Exit of Firms in the Long Run
Long-Run Equilibrium in a Perfectly Competitive Market
Long-run competitive equilibrium The situation in which the entry and exit of firms have resulted in the typical firm just breaking even.

33. The Decline of Apple Production in New York State
11 - 3
The Decline of Apple Production in New York State
When apple growers in New York State stopped breaking even, many sold their land to housing developers.

34. Perfect Competition and Efficiency
LEARNING OBJECTIVE 6
Productive Efficiency
Productive efficiency The situation in which a good or service is produced at the lowest possible cost.

35. How Productive Efficiency Benefits Consumers
11-2
LEARNING OBJECTIVE 6
How Productive Efficiency Benefits Consumers

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

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

38. Organic Food Trend Chips Out a Niche in Snack Food Isle

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

40. Assignments for March 23:
Pre-read Ch. 12, including:
Review Questions: p. 432, 1.1 – 1.3; p. 436, 4.1 & 4.2; p. 438, 6.1 & 6.2 (1st edition: 1, 2, 3, 7 8 & 10 on pp ); and
Problems and Applications: p. 432, 1.4; p. 433, 2.5; p. 435, 3.3; & p. 4.34, 2.11 (1st edition: 1, 3, 5 & 17 on pp ).