Chapter 24: Perfectly Competitive Markets

1. Chapter 24: Perfectly Competitive Markets Principles of MicroEconomics: Econ102

2. A Perfectly Competitive Market is one that…… • ……………meets the conditions of: • Many buyers and sellers: all participants are small relative to the market. • All firms selling identical products • No barriers to new firms entering the market.

3. A Perfectly Competitive Firm Faces a Horizontal Demand Curve A Perfectly Competitive Firm Cannot Affect the Market Price Because it is a……. Price taker: A buyer or seller that is unable to affect the market price.

4. The Market Demand for Wheat vs. the Demand for One Farmer’s Wheat

5. How a Firm Maximizes Profit in a Perfectly Competitive Market Profit: Total revenue minus total cost. Profit = TR – TC where, Total Revenue (TR): Price multiplied by quantity, units or output produced. TR=P x Q

6. Revenue for a Firm in a Perfectly Competitive Market Average revenue (AR): Total revenue divided by the number of units sold. Marginal revenue (MR): Change in total revenue from selling one more unit.

7. Revenue for a Firm in a Perfectly Competitive Market For a firm in a perfectly competitive market, price is equal to both AR and MR.

8. The Profit-Maximizing Level of Output (PMLO) for a Perfectly Competitive Firm is where MR=MC

9. The Profit-Maximizing Level of Output (PMLO) • Conclusions: • The PMLO is where the difference between total revenue and total cost is the greatest. • The PMLO is also where the marginal revenue equals marginal cost, or MR=MC. • One more conclusion: • For a firm in a perfectly competitive industry, price is equal to marginal revenue, or P=MR. So, it logically follows that P=MC, because MR=MC

10. Illustrating Profit or Loss on the Cost Curve Graph Profit = (P x Q) TC Or Profit = (PATC)Q

11. Showing a Profit on the Cost Curve Graph When P > ATC, the firm makes a profit

12. Showing a Loss and Breaking Even on the Cost Curve Graph When P = ATC, the firm breaks even (its total cost equals its total revenue) When P < ATC, the firm experiences losses

13. Deciding Whether to Produce or to Shut Down in the Short-Run • In the short-run a firm suffering losses has two choices: • Continue to produce: Only if TR is greater than its variable costs. • Stop production by shutting down temporarily • Sunk cost: • A cost that has already been paid and that cannot be recovered.

14. The Supply Curve of the Firm 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.

15. Long-Run Equilibrium in a Perfectly Competitive Market Long-run Competitive Equilibrium: The situation in which the entry and exit of firms have resulted in the typical firm just breaking even.

16. “If Everyone Can Do It, You Can’t Make Money at It” – Economic Profit Leads to Entry of New Firms

17. “If Everyone Can Do It, You Can’t Make Money at It” – Economic Losses Lead to Exit of Firms

18. “If Everyone Can Do It, You Can’t Make Money at It” – Economic Losses Lead to Exit of Firms

19. The Long-Run Supply Curve in a Perfectly Competitive Market Long-run Supply Curve: A curve showing the relationship in the long run between market price and the quantity supplied. In the long-run, a perfectly competitive market will supply whatever amount of a good consumers demand at a price determined by the minimum point on the typical firm’s average total cost curve.

20. The Long-Run Supply Curve in a Perfectly Competitive Market

21. Allocative and Productive Efficiency Allocative Efficiency: The situation where 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. For allocative efficiency to hold, firms must charge a price equal to marginal cost. Productive Efficiency: The situation where every good or service is produced at the lowest possible cost. For productive efficiency to hold, firms must produce at the minimum point of average total cost.