1. Chapter 9 Supply Under Perfect Competition Introduction to Economics (Combined Version) 5th Edition

2. Market Structure  Market structure is the characteristics of the market environment; such as the nature of the product, number and size of competitors, and conditions of entry and exit, that shape the ways in which a firm interacts with its customers and competitors.  Market structure matters because it helps determine the constraints a firm faces in making decisions related to pricing and profit maximization. Introduction to Economics (Combined Version) 5th Edition

3. Perfect Competition  Many small firms  Each has small market share  Product is homogeneous  Entry is unrestricted  Equal access to information  Example: Some kinds of farming Introduction to Economics (Combined Version) 5th Edition

4. Monopoly  One firm  100% market share  Unique product  Restricted entry  Possible restrictions on information  Example: Post office monopoly on first-class mail Introduction to Economics (Combined Version) 5th Edition ww.pdclipart.org

5. Oligopoly  A few firms  At least some have large market shares  Homogeneous or differentiated products  Entry may be restricted  Possible restrictions on information  Example: Airlines Introduction to Economics (Combined Version) 5th Edition

6. Monopolistic Competition  Many firms  Each has small market share  Product differentiated by quality, location, style, etc.  Unrestricted entry  Possible restrictions on information  Example: Hotels in a resort community Introduction to Economics (Combined Version) 5th Edition

7. Demand for a Perfect Competitor  The perfectly competitive firm is a price taker  It is so small relative to the market as a whole that its decisions do not significantly affect the market price, so the demand curve it faces is perfectly elastic. Introduction to Economics (Combined Version) 5th Edition

8. Profit Maximization for Perfect Competitor  Assume a perfectly competitive firm and a market price P=50  The maximum profit will be earned at a quantity Q* where P = MC and MC is increasing  At a lower Q, P>MC so revenue from one more unit will exceed the cost of that unit  At a higher Q, P<MC so revenue from one more unit will be less than the cost of that unit Introduction to Economics (Combined Version) 5th Edition

9. Profit Maximization vs. Loss Minimization  If P>ATC where P=MC, then the firm will earn a positive profit at that point (point a)  If ATC>P>AVC where P=MC, then “ profit maximization ” will really mean loss minimization, for example, point b Introduction to Economics (Combined Version) 5th Edition

10. Profit Maximization vs. Loss Minimization  At point b, price is enough to pay variable costs in full.  After variable costs are paid, there is enough revenue left to pay part, but not all of fixed costs.  If market conditions are expected to return to profitability in the future, short-run losses are minimized by operating at point b Introduction to Economics (Combined Version) 5th Edition

11. Example: Housing Construction  During a downturn in the housing market, a building contractor may continue to operate even though prices for contractor services are low.  Revenue is enough to cover variable costs (workers ’ wages) with enough left over to pay part, but not all, of fixed costs (tools and heavy equipment).  When the housing market recovers, prices will rise and profits will return. Introduction to Economics (Combined Version) 5th Edition

12. Short-Run Shutdown  Suppose that the firm is expected to be profitable in the long run but, in the short run, P<AVC  The firm should consider shutting down in the short-run to minimize operating losses  Possible exceptions:  Continue operating to avoid losing your regular customers  Continue operating to retain loyalty of key employees Introduction to Economics (Combined Version) 5th Edition

13. Example: Seasonal Resorts  Some ski resorts do not have enough demand to even cover their variable costs of operation in the summer.  They shut down in the summer to minimize losses.  Other mountain resorts have enough demand from hikers and sightseers to remain open all year.  Exercise: Draw diagrams to illustrate each possibility. Introduction to Economics (Combined Version) 5th Edition

14. MC Curve and the Supply Curve  As the price increases, the profit-maximizing quantity will increase  The positively-sloped segment of the marginal cost curve above minimum average variable cost can be considered the firm ’ s supply curve  Points where price intersects the negatively-sloped segment of the MC curve are not part of the supply curve Introduction to Economics (Combined Version) 5th Edition

15. Industry Supply Curve  A short-run industry supply curve can be obtained by summing the supply curves of individual firms. Here this method is shown for the first three firms in an industry. The supply curves of additional firms would be added in the same way. Introduction to Economics (Combined Version) 5th Edition

16. Long-Run Equilibrium Long-run equilibrium in a perfectly competitive industry requires that the firm 1.have no short-run incentive to change the level of its output 2.have no long-run incentive to change the size of the plant used to produce its output 3.have no long-run incentive to enter or leave the industry This requires that price, short-run marginal cost, short-run average total cost, and long- run average cost all have the same value in equilibrium Introduction to Economics (Combined Version) 5th Edition

17. Entry in Perfect Competition  An increase in demand temporarily increases price. With positive economic profit, new firms will enter. Supply shifts to right and price returns to AVC. Introduction to Economics (Combined Version) 5th Edition

18. Exit from Perfect Competition  A decrease in demand temporarily lowers price. With negative economic profit (assuming no sunk costs), some firms leave the market. As they do, supply shifts to left and price returns to AVC Introduction to Economics (Combined Version) 5th Edition

19. Industry Supply with Rising Input Prices  This pair of diagrams show what happens if industry expansion causes input prices to rise. As output expands, rising input prices push up the firm’s marginal cost curve from MC 1 to MC 2, and its average total cost from ATC 1 to ATC 2. The result is a new long-run equilibrium price that is higher than the initial price. The long-run industry supply curve thus has a positive slope. Introduction to Economics (Combined Version) 5th Edition