1 / 27

Lecture notes

Lecture notes. Prepared by Anton Ljutic. CHAPTER EIGHT. Perfect Competition. This Chapter Will Enable You to:. Distinguish between a firm , an industry and a market Explain the conditions necessary for a perfectly competitive market to exist

kiona-spence
Download Presentation

Lecture notes

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Lecture notes Prepared by Anton Ljutic

  2. CHAPTER EIGHT Perfect Competition

  3. This Chapter Will Enable You to: • Distinguish between a firm, an industry and a market • Explain the conditions necessary for a perfectly competitive market to exist • Use two approaches to explain how a firm might maximize its profits • Explain what is meant by break-even price and shut down price • Explain how a firm’s supply curve is derived • Explain the effect of a change in market demand or market supply on both the industry and the firm

  4. Industry vs. Market • Industry • A name for a group of producers • Market • Refers to the interaction of both producers and consumers

  5. Characteristics of Different Markets • Perfect competition • Many sellers, identical product, easy entry, no seller’s control over price: commodities such as wheat market in which all buyers and sellers are price takers • There are many firms, selling an identical product • Monopoly • There is a single firm, selling a unique product • Monopolistic competition • There are many firms, selling a differentiated product • Differentiated oligopoly • There are few firms, selling an identical product

  6. Characteristics of Different Markets Perfect competition Numerous sellers, identical product, easy entry, no control over price Example: commodities such as wheat Monopolistic competition Many sellers, differentiated product, easy entry, low control over price Example: restaurants Undifferentiated vs. Differentiated oligopoly Few sellers, identical vs. differentiated product, difficult entry, moderate vs. substantial control over price Example: oil refining vs. automotive and tobacco Monopoly One firm, unique product, very difficult entry, substantial control over price Example: local telephone providers, cable

  7. Conditions for Perfect Competition to Exist • Large number of small buyers and sellers, all of whom are price takers • No preferences shown (undifferentiated product) • Easy entry and exit by both buyers and sellers • The same market information available to all to make rational production and purchasing decisions

  8. Examples of Perfectly Competitive Markets • World markets for commodities like aluminum, zinc, cotton, rubber, oil,wheat • Agricultural products (though Canada has marketing boards) True competition exists between a wheat farmer in Alberta and another in Manitoba, not between Coca-Cola and Pepsi or between Reebok and Nike

  9. The Competitive Industry and the Firm Market S and D Single firm’s D P S1 P of wheat D*=AR=MR $10 D1 Q Q Figure 8.1

  10. Total, Average and Marginal Revenue • Total revenue (TR) • Price times output (P x Q) • Average revenue (AR) • The amount of revenue received per unit sold • To calculate it, you divide total revenue (TR) by output (Q) • Marginal revenue • The extra revenue derived from the sale of one more unit AR = TR / Q ; MR =  TR /  Q

  11. Price, Profit and Output Under Perfect Competition (I) • Total profits • the difference between total revenue and total cost (TR – TC) • Break-even output • The level of output at which the sales revenue of the firm just covers fixed and variable costs, including normal profit (i.e., where TR = TC)

  12. Price, Profit and Output Under Perfect Competition (II) • A higher price opens a wider range of profitable outputs, increased production and greater profits • A lower price reduces the range of profitable outputs and results in lower production and smaller profit for producers

  13. Total Revenue, Costs and Profits TC TR TC T TR Break-even Figure 8.3 Q T

  14. The Marginal Approach to Profitability • Marginal profit • The additional economic profit from the production and sale of of an extra unit of output • To calculate it, divide  total profit by  output • To maximize its total profit, the firm should increase production to the point at which the marginal profit is zero, that is , where marginal revenue is equal to marginal cost

  15. Average and Total Profits Figure 8.5 AR, AC MC Break-even points AC P= AR= MR P1 Profit-max. Q MR=MC Q

  16. Break-Even and Shutdown Price • Break-even price • The price at which the firm makes only normal profits, that is, makes zero economic profits • Shutdown price • The price that is just sufficient to cover a firm’s variable costs

  17. Break-Even and Shutdown Price for Competitive Firm • The break-even price is Pbe. • The shut-down price is Psd AR, cost MC ATC AVC Pbe Pbe=Break-even P Psd Psd=Shut-down P Figure 8.7 Q

  18. Should the Firm Produce? At any output – is the price higher than AC? NO YES Firm makes economic profit Is price higher than AVC? Firm produces at a loss NO YES Shut-down

  19. The Firm’s Supply Curve The firm’s supply curve is the marginal cost curve MC above minimum AVC AR, cost ATC MC=supply AVC Figure 8.8 Q

  20. The Industry Demand and Supply Curves • The industry’s supply curve is the total of all the firms’ MC curves. • The equilibrium • price is $35 and the equilibrium quantity is 60. S = MC P $35 D 60 Q

  21. Short vs. Long Run

  22. The Long-Run Effects of an Increase in Demand • The increase in demand (D1 to D2) causes P to rise to P2 and Q to rise from a to b • In the long run • new firms enter the industry and the supply shifts to S2and Q rise to c • the market price falls • back to P1 • P1 is the long-run equilibrium price P S1 S2 P2 b P1 a c D2 D1 Q

  23. The Long-Run Effects of a Decrease in Demand • The decrease in demand (D1 to D2) causes P to fall to P2 and Q to fall from a to b • In the long run • Some firms exit the industry and the supply shifts left to S2 and Q falls to c • the market price rises • back to P1 • P1 is the long-run equilibrium price P S2 S1 P1 c a P2 D1 b D2 Q

  24. Constant-Cost Industry • Increases in demand are met by exact • increases in supply. • Price is unaffected. • The LRS curve is horizontal P D1 S1 D2 S2 D3 S3 LRS Q

  25. Decreasing-Cost Industry • Industry expansion leads to lower costs. • Price falls. • The LRS curve is downward-sloping P D1 S1 D2 S2 D3 S3 LRS Q

  26. Increasing-Cost Industry • Industry expansion leads to increasing costs. • Price rises. • The LRS curve is upward-sloping P D3 S3 D2 S2 D1 S1 LRS Q

  27. Chapter Summary: What to Study and Remember • distinction between a firm, an industry and a market • conditions necessary for a perfectly competitive market to exist • two approaches to explain how a firm might maximize its profits • what is meant by break-even price and shut down price • the derivation of a firm’s supply curve • the effect of a change in market demand or market supply on both the industry and the firm

More Related