1. Competitive Markets for Goods and Services
Chapter 9
Competitive Markets for Goods and Services

2. 1. PERFECT COMPETITION: A MODEL
Learning Objectives
Explain what economists mean by perfect competition.
Identify the basic assumptions of the model of perfect competition and explain why they imply price taking behavior.
Market structure can range from perfect competition and one end of the continuum to monopoly at the other.
Perfect competition is a model of the market based on the assumption that a large number of firms produce identical goods consumed by a large number of buyers.

3. 1.1 Assumptions of the Model
Price takers are individuals or firms who must take the market price as given.
Identical goods
A large number of buyers and sellers
Ease of entry and exit
Complete information

4. 1.2 Perfect Competition and the Real World
The perfectly competitive model has strong assumptions.
When we use the model we assume market forces determine prices.
We can understand most markets by applying the supply and demand model.
With this framework we can see how competition affect firms, consumer, and markets.

5. 2. OUTPUT DETERMINATION IN THE SHORT RUN
Learning Objectives
Show graphically how an individual firm in a perfectly competitive market can use total revenue and total cost curves or marginal revenue and marginal cost curves to determine the level of output that will maximize its economic profit.
Explain when a firm will shut down in the short run and when it will operate even if it is incurring economic losses.
Derive the firm’s supply curve from the firm’s marginal cost curve and the industry supply curve from the supply curves of individual firms.

6. 2.1 Price and Revenue S
TR = $0.40*10 = $4 D
Total revenue is a firm’s output multiplied by the price at which it sells that output.
EQUATION 2.1

7. Total Revenue, Marginal Revenue, and Average Revenue
TR, P=$0.40
TR, P=$0.60
0.60 = MR = AR = P
Slope=0.6
TR, P=$0.20
0.40 = MR = AR = P
Slope=0.4
0.20 = MR = AR = P
Slope=0.2

8. Price, Marginal Revenue, and Average Revenue
Marginal revenue is the increase in total revenue from a one-unit increase in quantity.
Average revenue is total revenue divided by quantity.
EQUATION 2.1
Marginal revenue, price, and demand for the perfectly competitive firm

9. Price, Marginal Revenue, and Average Revenue
A perfectly competitive firm faces a horizontal demand curve.

10. 2.2 Economic Profit in the Short Run
Economic profit, which equals total revenue minus total costs, is maximized at an output of 6,700 pounds of radishes per month
Total Revenue
Total Cost
2,680
The slope of a line drawn tangent to the total cost curve at 6,700 pounds is equal to 0.4, which is also equal to the slope of the total revenue curve. The slope of the total cost curve is marginal cost; the slope of the total revenue curve is marginal revenue.
$938
1,742
6,700
1,500

11. 2.3 Applying the Marginal Decision Rule
Producing to maximize economic profit. MC MR
Profit = $938
$0.14
0.26
ATC
6,700
Economic profit per unit is the difference between price and average total cost.

12. 2.4 Economic Losses in the Short run
Economic loss is the amount by which a firm’s total cost exceeds its total revenue.
Producing to minimize economic loss.
Producing to maximize economic profit. MC
MR1
A fall in demand
ATC
AVC
0.23
Total loss = $222.20
MR2
0.18
.018
0.14
4,444
2.1 10

13. 2.4 Economic Losses in the Short run
The shutdown point is the minimum level of average variable cost, which occurs at the intersection of the marginal cost curve and the average variable cost curve.
Shutting down to minimize economic loss MC
ATC
AVC
0.14
MR3
1,700

14. 2.5 Marginal Cost and SupplyMC
Industry supply
AVC 14 17 19
280
330
380

15. 3. PERFECT COMPETITION IN THE LONG RUN
Learning Objectives
Distinguish between economic profit and accounting profit.
Explain why in long-run equilibrium in a perfectly competitive industry firms will earn zero economic profits.
Describe the three possible effects on the costs of the factors of production that expansion or contraction of a perfectly competitive industry may have and illustrate the resulting long-run industry supply curve in each case.
Explain why under perfection competition output prices will change by less than the change in production cost in the short run, but by the full amount of the change in production cost in the long run.
Explain the effect of a change in fixed cost on price and output in the short run and in the long run under perfect competition.

16. 3.1 Economic Profit and Economic Loss
Economic versus accounting concepts of profit and loss
Explicit costs are changes that must be paid for factors of production such as labor and capital.
Accounting profit is profit computed using only explicit costs.
Implicit cost is a cost that is included in the economic concept of opportunity cost but that is not an explicit cost.
The long run and zero economic profits

17. Eliminating Economic Profits in the Long Run
When firms enter supply shifts right and MR shifts down S1 MC
MR1 S2
Profit = $938
0.26
ATC
$0.22
$0.22
MR2
6,700 D 13

18. Eliminating Economic Losses in the Long Run
When firms exit supply shifts left and MR shifts up MC S2
ATC C1 P2 P2
MR2
Loss S1 P1 P1
MR1 D Q2 Q1 q1 q2

19. 3.1 Economic Profit and Economic Loss
Entry, Exit, and Production Costs
Constant-cost industry are changes that must be paid for factors of production such as labor and capital.
Increasing-cost industry is profit computed using only explicit costs.
Decreasing-cost industry is a cost that is included in the economic concept of opportunity cost but that is not an explicit cost.
Long-run industry supply curve is a curve that relates the price of a good or service to the quantity produced after all long-run adjustments to a price change have been completed.

20. 3.1 Economic Profit and Economic Loss
SIC
SCC
SDC

21. 3.2 Changes in Demand and in Production Cost
An increase in demand increases profitability which leads to an increase in supply. S1
ATC MC S2 B B?
$2.30
$2.30
MR2 A C
1.70
1.70 A?
MR1 D2 D1 Q1 Q2 Q3 q1 q2

22. 3.2 Changes in Demand and in Production Cost