1. 1 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets

2. 2 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets

3. 3 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets CHAPTER 11 Firms in Perfectly Competitive Markets Fernando Quijano Prepared by: The market for organically grown food has expanded rapidly in the United States.

4. 4 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets 11.1Perfectly Competitive Market Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. 11.2How a Firm Maximizes Profit in a Perfectly Competitive Market. Explain how a firm maximizes profit in a perfectly competitive market. 11.3Illustrating Profit or Loss on the Cost Curve Graph Use graphs to show a firm’s profit or loss. 11.4Deciding Whether to Produce or to Shut Down in the Short Run Explain why firms may shut down temporarily. 11.5“If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.6Perfect Competition and Efficiency Explain how perfect competition leads to economic efficiency. CHAPTER 11 Chapter Outline and Learning Objectives Firms in Perfectly Competitive Markets

5. 5 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Firms in Perfectly Competitive Markets MARKET STRUCTURE CHARACTERISTIC PERFECT COMPETITION MONOPOLISTIC COMPETITIONOLIGOPOLYMONOPOLY Number of firms Type of product Ease of entry Examples of industries Many Identical High Growing Wheat Apples Many Differentiated High Clothing Stores Restaurants Few Identical or differentiated Low Manufacturing computers Manufacturing automobiles One Unique Entry blocked First-class mail delivery Tap water Table 11-1 The Four Market Structures

6. 6 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Perfectly competitive market A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market. Price taker A buyer or seller that is unable to affect the market price. A Perfectly Competitive Firm Cannot Affect the Market Price Perfectly Competitive Markets Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. 11.1 LEARNING OBJECTIVE

7. 7 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets FIGURE 11-1 A Perfectly Competitive Firm Faces a Horizontal Demand Curve Perfectly Competitive Markets The Demand Curve for the Output of a Perfectly Competitive Firm A firm in a perfectly competitive market is selling exactly the same product as many other firms. Therefore, it can sell as much as it wants at the current market price, but it cannot sell anything at all if it raises the price by even 1 cent. As a result, the demand curve for a perfectly competitive firm’s output is a horizontal line. In the figure, whether the wheat farmer sells 6,000 bushels per year or 15,000 bushels has no effect on the market price of $4. Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. 11.1 LEARNING OBJECTIVE

8. 8 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets FIGURE 11-2 The Market Demand for Wheat versus the Demand for One Farmer’s Wheat Perfectly Competitive Markets The Demand Curve for the Output of a Perfectly Competitive Firm In a perfectly competitive market, price is determined by the intersection of market demand and market supply. In panel (a), the demand and supply curves for wheat intersect at a price of $4 per bushel. An individual wheat farmer like Farmer Parker cannot affect the market price for wheat. Therefore, as panel (b) shows, the demand curve for Farmer Parker’s wheat is a horizontal line. Don’t Let This Happen to YOU! Don’t Confuse the Demand Curve for Farmer Parker’s Wheat with the Market Demand Curve for Wheat YOUR TURN: Test your understanding by doing related problem 1.6 at the end of this chapter. Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. 11.1 LEARNING OBJECTIVE

9. 9 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets How a Firm Maximizes Profit in a Perfectly Competitive Market Profit Total revenue minus total cost. Profit = TR – TC Revenue for a Firm in a Perfectly Competitive Market Average revenue (AR) Total revenue divided by the quantity of the product sold. Marginal revenue (MR) The change in total revenue from selling one more unit of a product. Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE

10. 10 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets How a Firm Maximizes Profit in a Perfectly Competitive Market NUMBER OF BUSHELS (Q) MARKET PRICE (PER BUSHEL) (P) TOTAL REVENUE (TR) AVERAGE REVENUE (AR) MARGINAL REVENUE (MR) 0 1 2 3 4 5 6 7 8 9 10 $4 4 $0 4 8 12 16 20 24 28 32 36 40 - $4 4 - $4 4 Table 11-2 Farmer Parker’s Revenue from Wheat Farming Revenue for a Firm in a Perfectly Competitive Market Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE

11. 11 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets How a Firm Maximizes Profit in a Perfectly Competitive Market QUANTITY (BUSHELS) (Q) TOTAL REVENUE (TR) TOTAL COST (TC) PROFIT (TR-TC) MARGINAL REVENUE (MR) MARGINAL COST (MC) 0 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 $2.00 5.00 7.00 8.50 10.50 13.00 16.50 21.50 28.50 38.00 50.50 -$2.00 1.00 3.50 5.50 7.00 7.50 6.50 3.50 -2.00 -10.50 — $4.00 4.00 — $3.00 2.00 1.50 2.00 2.50 3.50 5.00 7.00 9.50 12.50 Determining the Profit-Maximizing Level of Output Table 11-3 Farmer Parker’s Profits from Wheat Farming Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE

12. 12 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets How a Firm Maximizes Profit in a Perfectly Competitive Market Determining the Profit-Maximizing Level of Output FIGURE 11-3 The Profit-Maximizing Level of Output In panel (a), Farmer Parker maximizes his profit where the vertical distance between total revenue and total cost is the largest. Panel (b) shows that Farmer Parker’s marginal revenue (MR) is equal to a constant $4 per bushel. Farmer Parker maximizes profits by producing wheat up to the point where the marginal revenue of the last bushel produced is equal to its marginal cost, or MR = MC. Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE

13. 13 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets How a Firm Maximizes Profit in a Perfectly Competitive Market Determining the Profit-Maximizing Level of Output 1.The profit-maximizing level of output is where the difference between total revenue and total cost is the greatest. 2.The profit-maximizing level of output is also where marginal revenue equals marginal cost, or MR = MC. From the information in Table 11-3 and Figure 11-3, we can draw the following conclusions: Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE

14. 14 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Illustrating Profit or Loss on the Cost Curve Graph Profit = (P x Q)  TC Profit = (P  ATC) x Q or Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE

15. 15 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Showing a Profit on the Graph FIGURE 11-4 The Area of Maximum Profit Illustrating Profit or Loss on the Cost Curve Graph A firm maximizes profit at the level of output at which marginal revenue equals marginal cost. The difference between price and average total cost equals profit per unit of output. Total profit equals profit per unit multiplied by the number of units produced. Total profit is represented by the area of the green-shaded rectangle, which has a height equal to (P - ATC) and a width equal to Q. Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE

16. 16 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Solved Problem 11-3 Determining Profit-Maximizing Price and Quantity OUTPUT PER DAY TOTAL COST 0$10.00 120.50 224.50 328.50 434.00 543.00 655.50 772.00 893.00 9119.00 YOUR TURN: For more practice, do related problems 3.3 and 3.4 at the end of this chapter. Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE

17. 17 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Illustrating Profit or Loss on the Cost Curve Graph Don’t Let This Happen to YOU! Remember That Firms Maximize Their Total Profits, Not Their Profits per Unit YOUR TURN: Test your understanding by doing related problem 3.5 at the end of this chapter. Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE

18. 18 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets 1. P > ATC, which means the firm makes a profit. 2. P = ATC, which means the firm breaks even (its total cost equals its total revenue). 3. P < ATC, which means the firm experiences losses. Illustrating When a Firm Is Breaking Even or Operating at a Loss Illustrating Profit or Loss on the Cost Curve Graph Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE

19. 19 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets FIGURE 11-5 A Firm Breaking Even and a Firm Experiencing Losses Illustrating When a Firm Is Breaking Even or Operating at a Loss Illustrating Profit or Loss on the Cost Curve Graph In panel (b), price is below average total cost, and the firm experiences a loss. The loss is represented by the area of the red-shaded rectangle, which has a height equal to (ATC - P) and a width equal to Q. In panel (a), price equals average total cost, and the firm breaks even because its total revenue will be equal to its total cost. In this situation, the firm makes zero economic profit. Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE

20. 20 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Losing Money in the Medical Screening Industry Making the Connection YOUR TURN: Test your understanding by doing related problem 3.8 at the end of this chapter. Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE

21. 21 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Deciding Whether to Produce or to Shut Down in the Short Run 1.Continue to produce 2.Stop production by shutting down temporarily Sunk cost A cost that has already been paid and that cannot be recovered. In the short run, a firm experiencing losses has two choices: Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE

22. 22 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets When to Close a Laundry Making the Connection Keeping a business open even when suffering losses can sometimes be the best decision for an entrepreneur in the short run. YOUR TURN: Test your understanding by doing related problems 4.5 and 4.6 at the end of this chapter. Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE

23. 23 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Deciding Whether to Produce or to Shut Down in the Short Run Shutdown point The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run. The Supply Curve of a Firm in the Short Run Total revenue < Variable cost, (P × Q) < VC P < AVC or, in symbols: If we divide both sides by Q, we have the result that the firm will shut down if: Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE

24. 24 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets FIGURE 11-6 The Firm’s Short-Run Supply Curve Deciding Whether to Produce or to Shut Down in the Short Run The Supply Curve of a Firm in the Short Run For any given price, we can determine the quantity of output the firm will supply from the marginal cost curve. In other words, the marginal cost curve is the firm’s supply curve. The firm will shut down if the price falls below average variable cost. The marginal cost curve crosses the average variable cost at the firm’s shutdown point. This point occurs at output level Q SD. For prices below P MIN, the supply curve is a vertical line along the price axis, which shows that the firm will supply zero output at those prices. The red line in the figure is the firm’s short-run supply curve. Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE

25. 25 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets FIGURE 11-7 Firm Supply and Market Supply Deciding Whether to Produce or to Shut Down in the Short Run The Market Supply Curve in a Perfectly Competitive Industry We can derive the market supply curve by adding up the quantity that each firm in the market is willing to supply at each price. In panel (a), one wheat farmer is willing to supply 15,000 bushels of wheat at a price of $4 per bushel. If every wheat farmer supplies the same amount of wheat at this price and if there are 167,000 wheat farmers, the total amount of wheat supplied at a price of $4 will equal 15,000 bushels per farmer × 167,000 farmers = 2.5 billion bushels of wheat. Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE

26. 26 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run EXPLICIT COSTS Water Wages Organic fertilizer Electricity Payment on bank loan $10,000 $15,000 $10,000 $5,000 $45,000 IMPLICIT COSTS Foregone salary Opportunity cost of the $100,000 she has invested in her farm $30,000 $10,000 Total cost$125,000 Economic Profit and the Entry or Exit Decision Table 11- 4 Farmer Moreno’s Costs per Year Economic profit A firm’s revenues minus all its costs, implicit and explicit. Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE

27. 27 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Economic Profit Leads to Entry of New Firms FIGURE 11-8 The Effect of Entry on Economic Profits Economic Profit and the Entry or Exit Decision “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE

28. 28 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets FIGURE 11-9 The Effect of Exit on Economic Losses Economic Losses Lead to Exit of Firms Economic Profit and the Entry or Exit Decision “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run

29. 29 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets The Effect of Exit on Economic Losses FIGURE 11-9 The Effect of Exit on Economic Losses (continued) Economic Losses Lead to Exit of Firms Economic Profit and the Entry or Exit Decision “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE

30. 30 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs. Long-Run Equilibrium in a Perfectly Competitive Market Long-run competitive equilibrium The situation in which the entry and exit of firms has resulted in the typical firm breaking even. Economic Losses Lead to Exit of Firms Economic Profit and the Entry or Exit Decision “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE

31. 31 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets FIGURE 11-10 The Long-Run Supply Curve in a Perfectly Competitive Industry The Long-Run Supply Curve in a Perfectly Competitive Market “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE

32. 32 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Long-run supply curve A curve that shows the relationship in the long run between market price and the quantity supplied. Increasing-Cost and Decreasing-Cost Industries Industries with upward-sloping long- run supply curves are called increasing-cost industries. Industries with downward-sloping long- run supply curves are called decreasing-cost industries. The Long-Run Supply Curve in a Perfectly Competitive Market “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE

33. 33 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Easy Entry Makes the Long Run Pretty Short in the Apple iPhone Apps Store Making the Connection Economic profits are rapidly competed away in the iPhone apps store. YOUR TURN: Test your understanding by doing related problem 6.7 at the end of this chapter. In a competitive market, earning an economic profit in the long run is extremely difficult. And the ease of entering the market for iPhone apps has made the long run pretty short. Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE

34. 34 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Perfect Competition and Efficiency Productive efficiency The situation in which a good or service is produced at the lowest possible cost. Productive Efficiency Explain how perfect competition leads to economic efficiency. 11.6 LEARNING OBJECTIVE

35. 35 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets How Productive Efficiency Benefits Consumers Solved Problem 11-6 YOUR TURN: For more practice, do related problems 6.4, 6.5, and 6.6 at the end of this chapter. In the long run, firms only break even on their investment in producing high-technology goods. That result implies that investors in these firms are also unlikely to earn an economic profit in the long run. Explain how perfect competition leads to economic efficiency. 11.6 LEARNING OBJECTIVE

36. 36 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Perfect Competition and Efficiency 1.The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. 2.Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit. 3.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. Allocative Efficiency Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them. Explain how perfect competition leads to economic efficiency. 11.6 LEARNING OBJECTIVE

37. 37 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Perfect Competition and Efficiency Allocative efficiency A state of the economy in which production represents 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. Allocative Efficiency Explain how perfect competition leads to economic efficiency. 11.6 LEARNING OBJECTIVE

38. 38 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets AN INSIDE LOOK Figure 1 The demand for a product increases after it is “green certified.” The graph assumes that the firm did not spend money to acquire certification for its product. It Isn’t Easy—or Cheap—to Be Green >> Figure 2 The demand for a product increases after it is “green certified.” The marginal cost and average total cost curves shift up due to the cost of certification.

39. 39 of 39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. Chapter 11: Firms in Perfectly Competitive Markets Allocative efficiency Average revenue (AR) Economic loss Economic profit Long-run competitive equilibrium Long-run supply curve Marginal revenue (MR) Perfectly competitive market Price taker Productive efficiency Profit Shutdown point Sunk cost KEY TERMS