1. Today n Perfect competition n Profit-maximization in the SR n The firm’s SR supply curve n The industry’s SR supply curve

2. Perfect Competition Chapter 21

3. Market Structure n Market Structure: the key features of a market, including: –# of firms –type of product –nature of firm’s cost –# of buyers n Market structure is usually defined in terms of sellers.

4. Perfect Competition = Manyfirms Oligopoly = A few firms Four Basic Models Monopoly = One firm Monopolistic Competition = Some firms

5. A Rule of Thumb n The fewer the firms in the market, the more control each firm has over price.

6. Perfect Competition

7. Perfect Competition: Five Assumptions n Homogeneous Product: Goods produced by different sellers are perceived to be identical by consumers. n Perfect Information about Prices n Given the first two assumptions, will a seller be able to sell his product for a price higher than his competitors?

8. Assumptions 3-5 n The market is large enough to support many sellers. n The firms are price takers: they acts as if their own output has no effect on price. n No barriers to entry: firms can enter and exit the market freely.

9. Examples of Perfectly Competitive Industries n wheat, corn, etc. n steel n coal

10. Revenue (assuming fixed price per unit) n Total Revenue (TR) = price x quantity sold (PQ) n Average Revenue (AR) = (TR/Q) = (PQ/Q) = P Marginal Revenue (MR) =  TR/  Q the change in TR when output rises by one unit. n Profits = TR - TC (or TR - TFC - TVC)

11. Note on Marginal Revenue n The above definition is a general definition of MR that works for all industry structures. In perfect competition, since firms are price takers, MR = P = AR. n For any other market structure, MR < P.

12. Demand for a Particular Firm’s Output qQ D S PPTypical FirmIndustry or Market The price-taking firm faces a perfectly elastic demand for its product at the market price. Q* P* d = AR = MR

13. Short-Run Production Decisions

14. Decision 1 n Should the firm produce anything? n Produce if: n profit producing > profit not producing n TR - TFC - TVC > 0 - 0 -TFC n TR > TVC n TR/Q > TVC/Q n Produce in SR ifP > AVC n Produce in SR if P > AVC

15. Graph of Decision 1 q P Typical Firm P1P1 Produce P2P2 Don’t Produce AV C

16. Decision 2 n If the firm does produce in the SR, then: n Decision 2: How much should it produce in the SR? n max profits = max (TR - TFC - TVC) n Given TFC do not vary with output, we can ignore them when choosing output. If we choose q to maximize TR- TVC, we will also be maximizing profits.

17. Total Revenue on Graph of Marginal Revenue q P P = AR = MR TR is the area under MR.

18. Total Variable Cost on Graph of Marginal Cost q P MC TVC is the area under MC.

19. Total Revenue Minus Total Variable Cost on Graph q P MC If we maximize TR - TVC then we will maximize profits. TR - TVC is maximized when MR = MC. Profit over operating costs. MR = P = AR q*

20. The Firm’s Profit-Maximizing Rule n Choose quantity where MR = MC (given MC is sloping upward and AVC are covered).

21. Price-Taking and Profit- Maximization n For price-taking firms, MR = P. n Maximize profits by choosing q where MC = P.

22. The Firm’s Supply Curve n The firm’s supply curve tells how much the firm will produce in the short run at every possible price, given a fixed plant size.

23. Graphing the Firm’s Supply Curve q P MC P0P0 AVC

24. Graphing the Firm’s Supply Curve q P MC P0P0 P1P1 AVC

25. Graphing the Firm’s Supply Curve q P MC P0P0 P1P1 P2P2 AVC

26. Graphing the Firm’s Supply Curve q P MC P0P0 P1P1 P2P2 P3P3 AVC

27. Graphing the Firm’s Supply Curve q P MC P0P0 P1P1 P2P2 P3P3 AVC SRS

28. Firm’s SR Supply Curve n The firm’s supply curve is equal to its MC curve above AVC. n P 1 is sometimes called the “shutdown point” because if price falls below P 1, the firm shuts down in the short run.

29. Industry Short Run Supply Curve n Industry SR Supply Curve: tells us how much the industry will produce at every possible price, given fixed plant sizes and a fixed number of firms.

30. Deriving Industry Supply P P P 10 q Q Industry Firm 2 Firm 1 mc 1 15 22 25 32 42 20 SRS 1 2 3 mc 2 17 15 The industry supply curve is the horizontal summation of the firms’ marginal cost curves (above their AVC curves).

31. Next Time n SR market equilibrium n Changes in equilibrium n LR equilibrium

32. Group Work n The firm’s SR supply curve. n The Industry’s SR supply curve.

33. The Price-Taking Firm’s SR Supply Curve n Look at the graph (next slide) to answer these questions: n In the short run, if the market price is $3, what quantity will the firm produce? _____ n In the short run, if the market price is $5.25, what quantity will the firm produce? _____ n In the short run, if the market price is $7.50, what quantity will the firm produce? _____ n Trace out the firm's short-run supply curve.

34. Firm’s SR Supply Curve

35. Short Run Industry Supply n Suppose that there are 100 price-taking firms in this industry and all have identical cost curves to the firm depicted in the graph. n Draw the short-run industry supply curve in the right-hand panel of the next slide. Be sure to use the scale provided.

36. Short Run Industry Supply