1. Perfect Competition Tutorial 8

2. Page 2 Firm’s Output Choice  Economists assume ALL firms maximize economic profits,  As shown by the cost functions developed in the last chapter, total costs depends on quantity of output of the firm.  To see how a firm’s revenue depends on its output level, we must look at the demand for the firm’s product, which is highly related to the market structure in which the firm is operating. -Perfect Competition -Monopoly -Monopolistic Competition -Oligopoly

3. Page 3 Perfect Competition  Characteristics of perfectly competitive markets: -Large numbers of small buyers and sellers: price takers -Homogeneous products -Perfect information -Free entry and exit

4. Page 4 Demand Curve facing a Competitive Firm Qq pp D S pepe d = p = MR Market Individual Firm QeQe Marginal revenue: additional revenue obtained by producing one more unit of output.

5. Page 5 Short-run Output Decision Qq pp D S pepe d = p = MR Market Individual Firm QeQe SMC MC = MR q1q1 q2q2 q* At q 1, p > MC At q 2,p < MC

6. Page 6 Short-run Output Decision  To find the profit of the firm:  To show the profit in a per-unit diagram, it is often convenient to represent the profit as P q p = MR AC * q*q* p*p* SAC SMC π

7. Page 7 Short-run Shutdown Decision  What if the firm is making economic loss? -Keep on Production -Shut down  Which one to choose? Depending on market price  Shutdown: Do not produce temporarily. -Loss = TFC  Case 1: When SAC > P > AVC SAC x q > P x q > AVC x q TC > TR > TVC Economic Loss = TC – TR < TC – TVC (= TFC)  Case 2: When SAC > AVC > P SAC x q > AVC x q > P x q TC > TVC > TR Economic Loss = TC – TR > TC – TVC (= TFC)  The firm will shut down only if its revenues cannot cover its variable cost

8. Page 8 Short-run Shutdown Decision p($) q p = MR AC q*q* p*p* SAC AVC SMC AVC TR – VC AFC Loss FC

9. Page 9 Firm’s Short-run Supply Curve  The firm’s supply curve shows how much it will produce at various output prices.  The positively-sloped segment of the firm’s SMC curve above the point of minimum AVC, therefore, is the firm’s short-run supply curve. o For prices below this level, the firm will choose to shut down, so this price level is called the shut-down price. p($) q q1q1 p1p1 A B AVC SMC C p0p0 p2p2 q2q2 q0q0

10. Page 10 Short-run Market Supply Curve  The short-run market supply curve is derived by horizontal summing all the individual firms’ supply curves: q1q1 Q pp S1S1 p1p1 MarketFirm 1 p S2S2 qq SS q2q2 q 3 p2p2 q 4 q 1 + q 2 q 3 + q 4 Firm 2

11. Page 11 Short-run Competitive Market Equilibrium  The market equilibrium occurs when the quantity demanded by all consumers equals the total quantity supplied by all the firms in the market. That is, Qq p p D SS p* Q* p = MR MarketIndividual Firm SAC SMC q*

12. Page 12 Long-run Output Choice and Firm’s Supply Curve  In the long run, a firm may adapt all of its inputs, such as adjusting plant size (capital employed), to fit market condition. Therefore, we should use the firm’s long-run cost functions for long-run analysis.  As firm will exit the market if it makes an economic loss in the long run. Therefore, the firm’s long-run supply curve is its long-run marginal cost curve above the minimum of its long-run average cost curve p($) q SAC 2 q2q2 SAC 1 LAC LMC SMC 1 SMC 2 q1q1 p1p1 E MR

13. Page 13 Free Entry and Long-run Competitive Market Equilibrium  In the long run, new firms can enter the industry. -New firms enter when π > 0. -Existing firms exit when π < 0. Q q p p SS 0 p2p2 Market Individual Firm AC SAC q2q2 q1q1 SS 1 Q1Q1 p1p1 D 1 Q2Q2 SMC MC

14. Page 14 Comparative statics analysis  Increase in Demand: Q q p p D1D1 SS 1 p1p1 Q1Q1 Market Individual Firm AC SAC q1q1 q2q2 SS 2 Q2Q2 p2p2 D 2 Q3Q3 SMC

15. Page 15 Comparative statics analysis: Long run  The long-run market supply curve can be derived indirectly by connecting the long-run equilibrium before and after the increase in market demand. -Why not derive it by horizontal summation of all firms’ long-run supply curve? p Q D1D1 D2D2 E2E2 E1E1 S

16. Page 16 Comparative statics analysis: Long run  Long-run Market Supply Curve Q q p p D1D1 SS 1 p1p1 Q1Q1 Market Individual Firm AC SAC q1q1 q2q2 SS 2 Q2Q2 p2p2 D 2 Q3Q3 SMC LS

17. Page 17 Comparative statics analysis: Long run  The long-run market supply curve can be derived indirectly by connecting the long-run equilibrium before and after the increase in market demand. -Why not derive it by horizontal summation of all firms’ long-run supply curve?  The long-run supply curve is horizontal at price equal to the minimum long-run average cost. -Free entry and exit always drive price to this level (zero profit) -Constant-cost industry: It is assumed that entry of new firms will have no effect on input prices

18. Page 18 Discussion Question 2: Beijing’s Silk Market (Xiushui Market)  The Silk Street attracts approximately 20,000 visitors daily (from 9am to 9pm) on weekdays and between 50,000 and 60,000 on weekends as of 2006.Many of the stalls have over the years gained local and international reputation for selling counterfeit luxury designer brands at relatively low prices.

19. Page 19 Discussion Question 2: Beijing’s Silk Market (Xiushui Market)  In an opinion piece published in The Wall Street Journal on 17 June, 2008, Chinese Vice-Premier Wang Qishan mentioned that Beijing’s Silk Market has gone “through rectification and has since become a distribution centre of famous brands”. But in reality, many stalls have carried on selling counterfeit luxury designer brands despite growing pressures from the Chinese government and famous brand name companies. “True, there is not much shouting or pulling at customers walking down the aisles full of handbag and shoe stalls. But if you are caught looking at a bag for more than two seconds, a saleslady quickly hisses at you: “ Want Gucci?” …”

20. Page 20 Discussion Question 2: Beijing’s Silk Market (Xiushui Market)  According to the article, the problem persists because of weak enforcement of the intellectual property law.  “In reality the cost of proving a criminal charge is very high,” said National Copyright Administration deputy director – general Xu Chao. “It’s very difficult, hence the limited number of criminal arrests.” (Source: SCMP, July 7, 2008) a.Consider the counterfeiters industry, which is highly competitive. Suppose the government runs a confiscation program to arrest the counterfeiters from time to time. The program can only arrest limited number of counterfeiters. What would happen to the profits and prices of the remaining firms, which were not arrested in short run? b.What would be the long run adjustment in the market after the confiscation program? Is this kind confiscation program an effective way to deal with the piracy problem?

21. Page 21 Effects of the Confiscation Program P Qq P ($) LAC LMC SAC SMC S1S1 D q1q1 Q1Q1 P1P1 Individual FirmMarket S2S2 P2P2 Q2Q2 q2q2 MR 1 MR 2

22. Page 22 Discussion Question 2 c.Many people suggested other measures to be more effective, e.g. educating the youngsters about the importance of protecting the intellectual property rights were more effective ways to deal with piracy in long run. Do you agree?

23. Page 23 Effects of Successful Education P Qq P ($) LAC SAC SMC S1S1 D1D1 q1q1 Q1Q1 P1P1 Individual FirmMarket P2P2 Q2Q2 q2q2 D2D2 MR 1 MR 2 S2S2 LMC Q3Q3

24. Page 24 Discussion Question 3: Fishermen in HK  A report published in Hong Kong Economics Times on 11 June 2008 concerns the fishing market in Hong Kong. It is reported that the diesel price increased by 2.4 times in a year, which raised the cost of fishing significantly. How would this regulation affect the market and individual fishermen in the short run and long run? (Source: Hong Kong Economic Times, 11 June, 2008)

25. Page 25 Short-run Effects of Increase in (Variable) Cost P Qq P ($) SAC 2 SMC 2 S1S1 q1q1 Q1Q1 P1P1 Individual FirmMarket P2P2 Q2Q2 q2q2 MR 1 SAC 1 SMC 1 S2S2 LAC 2 LAC 1 MR 2 D

26. Page 26 Discussion Question 3: Fishermen in HK  If p < AVC, some fishermen may shutdown  “Because of the high diesel price, some fishermen’s two-day revenues of $4000 can only cover the diesel costs. Therefore, some of them have stopped fishing for some time,” said Mr. Lai.

27. Page 27 Long-run Effects of Increase in Cost P Qq P ($) SAC 2 SMC 2 S1S1 q1q1 Q1Q1 P1P1 Individual FirmMarket P2P2 Q2Q2 q2q2 MR 1 SAC 1 SMC 1 S2S2 LAC 2 LAC 1 MR 2 D MR 3 Q3Q3 q3q3 S2S2 P 3

28. Page 28 Discussion Question 3: Fishermen in HK  Starting from this year, some of the fishermen started to sell their boats to stop losses. Starting from January, 30 boats were sold in this year.  It leads to higher fish prices. Some of the fish prices rise by about 25%.

29. Page 29 Discussion Question 4 Suppose the book-printing industry is competitive and begins in a long-run equilibrium. a.Hi-Tech Printing Company employs an extra-ordinary manager that sharply reduces the cost of administrative costs (i.e. fixed cost in the short run). What happens to Hi-Tech’s profits and the price of books in short run? Will it attract new firms to enter the market in long run? b.Suppose you were the owner of Hi-Tech. What is the maximum amount that you would offer to keep the extra-ordinary manager to your own firm?

30. Page 30 Discussion Question 4 Qq pp p1p1 qAqA Typical Firm B SAC B SMC B qBqB Individual Firm A SMC A A Economic rent is the returns that are derived from extraordinarily productive inputs, which is scarce.