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Chapter 7 Perfect Competition

Chapter 7 Perfect Competition. Survey of Economics Irvin B. Tucker. Lecture Slides. What will I learn in this chapter?. This chapter discusses how competitive markets determine prices, output, and profits. What is market structure?.

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Chapter 7 Perfect Competition

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  1. Chapter 7Perfect Competition Survey of EconomicsIrvin B. Tucker Lecture Slides

  2. What will I learn in this chapter? • This chapter discusses how competitive markets determine prices, output, and profits

  3. What ismarket structure? • A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry and exit

  4. What isperfect competition? A market structure characterized by: 1. Large number of small firms 2. homogeneous product 3. very easy entry and exit

  5. What is meant by a large number of firms? • A large number of sellers condition is met when each firm is so small relative to the total market that no single firm can influence the market price

  6. What doeshomogeneous mean? • Goods that cannot be distinguished from one another. For example, farmer Brown’s wheat is identical to farmer Jones’s wheat.

  7. What conclusion can we make concerning a homogeneous product? • If a product is homogeneous, buyers are indifferent as to which seller’s product they buy

  8. What does very easy entry mean? • Perfect competition requires that a new firm faces no barriers to entry, such as financial, technical, or government-imposed barriers (licenses, permits, patents).

  9. What is the result of a firm conforming to the perfect competition model? • The firm is a price taker, which means it is a seller that has no control over the price of the product.

  10. What determines price in perfect competition? • Market Demand and Market Supply

  11. Exhibit 7.1(a) Market Supply and Demand Market Supply 140 S 120 100 Price per unit (dollars) E 80 70 60 Market Demand 40 20 D 0 40 20 60 80 100 Quantity of Output (thousands of units per hour)

  12. What determines the individual firm’s demand curve? • A horizontal line at the market price

  13. Exhibit 7.1(b) Individual firm demand 130 120 100 80 Demand D Price per unit(dollars) 70 60 40 20 2 0 4 6 10 8 Quantity of output ( units per hour)

  14. Why is this horizontal line the firm’s demand curve? • If the firm charges more than this price, it will not sell anything, and it has no incentive to charge less than this price

  15. Why is the firm’s demand curve horizontal at the market price? • Because the firm can sell all it produces at the market price

  16. Why does the firm have no incentive to charge less than the market price? • It can sell everything it brings to market at the market price

  17. What does the perfectly competitive firm control? • As a price taker, the only thing the firm controls is how many units it produces

  18. How many units should this firm produce? • The number of units that will maximize its profits, or minimize its losses

  19. What are the two methods to determine how many units to produce? • TR and TC method • MR and MC method

  20. Using the total revenue-total cost method, where should a firm produce? • Where the distance between TR and TC is the greatest

  21. 7.2

  22. Exhibit 7.3(a) Total Revenue and Total Cost 800 TR 700 TC 600 500 Max profit=$205 Total Revenue and Total Cost (dollars) 400 300 200 100 Loss 0 1 2 3 4 5 6 7 8 9 10 11 12 9 Quantity of Output (units per hour)

  23. Exhibit 7.3(b) Profit or loss 250 200 150 Profit (dollars) 100 Profit= $205 50 0 1 2 3 4 5 6 7 8 10 11 12 9 -50 Loss (dollars) Maximum profit output Loss -100 Quantity of Output (units per hour)

  24. What ismarginal revenue (MR)? MR = TR / 1 output The change in total revenue from the sale of one additional unit of output. ∆ ∆

  25. What ismarginal cost (MC)? • The change in total cost from the sale of one unit of output. ∆ ∆ MC = TC / 1 output

  26. Using the marginal revenue and marginal cost method, where should a firm produce? MR = MC

  27. Why should a firm continue to produce as long as MR > MC? • As long as MR is greater than MC, profit is being made on that last unit produced and sold.

  28. Why will a firm not produce any unit where MR < MC? • At any unit of output where MR < MC, the firm incurs a loss.

  29. Exhibit 7.4(a) Price, Marginal Revenue, and Cost per Unit MC 120 100 MR=MC 80 Price and Cost per unit (dollars) MR 70 Profit=$205 ATC 60 AVC 40 20 0 8 9 12 2 4 6 10 Quantity of Output (units per hour)

  30. Exhibit 7.4(b) Profit or loss 250 200 150 Profit (dollars) Profit= $205 100 50 0 1 2 3 4 5 6 7 8 10 11 12 9 -50 Loss (dollars) Maximum profit output Loss -100 Quantity of Output (units per hour)

  31. Exhibit 7.5 Short-Run Loss Minimization Using the Marginal Revenue Equals Marginal Cost Method for a Perfectly Competitive Firm

  32. Firm will shut down Price (MR) is below minimum average variable cost

  33. Exhibit 7.6 The Short-Run Shutdown Point for a Perfectly Competitive Firm 120 MC 110 100 90 80 70 ATC Price & Cost per unit(dollars) 60 AVC Shutdown point 50 40 MR 25 10 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of output (units per hour)

  34. Exhibit 7.7 The Firm’s Short-Run Supply Curve MC 120 Supply curve 100 C 90 MR3 80 Price per unit(dollars) 70 ATC 60 AVC B 45 MR2 A 30 MR1 20 10 0 1 2 3 4 8 9 11 12 10 5.5 7 Quantity of output(units per hour)

  35. What is the perfectly competitive firm’s short-run supply curve? • The firm’s marginal cost curve above the minimum point on its average variable cost curve

  36. Exhibit 7.7 The Firm’s Short-Run Supply Curve MC Supply curve 90 MR3 C 80 70 ATC 60 B AVC Price per unit(dollars) 45 MR2 A 30 MR1 20 10 0 2 3 4 11 8 9 12 1 5.5 7 10 Quantity of output (units per hour)

  37. What is the perfectly competitive industry’s supply curve? • The horizontal summation of the MC curves of all firms in the industry above that lie above the minimum point on their AVC curves.

  38. Exhibit 7.8 Deriving the Industry Short-Run Supply Curve Computech MC curve + Western Computer Co. = Industry Supply Curve MC S= ∑ MC MC 90 90 90 Price and marginal 40 40 40 cost per unit (dollars) 0 0 0 11 15 7 11 26 18 Quantity of Output (units per hour) Quantity of Output (units per hour) Quantity of Output (units per hour)

  39. Exhibit 7.9(a) Individual Short-Run Competitive Equilibrium 120 MC 100 80 Price and cost per unit(dollars) E MR 60 Profit ATC 40 AVC 20 6 0 12 9 10 2 4 8 Quantity of output (units per hour) 39

  40. Exhibit 7.9(b) Industry Short-Run Competitive Equilibrium S = MC 120 100 80 Price and Cost per unit (dollars) E 60 40 20 D 80 20 100 40 0 60 120 40 Quantity of output (thousands of units per hour)

  41. What is a normal profit? • The minimum profit necessary to keep a firm in operation

  42. In the long-run, what happens when economic profits are made? • When firms make more than a normal profit, firms enter the industry; as supply increases, a downward pressure is put on prices

  43. In the long-run, what happens when losses are made? • When firms make less than a normal profit, firms leave the industry; as supply decreases, an upward pressure is put on prices

  44. In the long-run, where is equilibrium? • At the market price that enables firms to make a normal profit

  45. Exhibit 7.10 Long-Run Perfectly Competitive Equilibrium SRATC SRMC 105 LRAC 90 75 E Price and cost per unit(dollars) 60 MR 45 30 15 0 10 2 6 5 8 1 3 4 7 9 Quantity of output(units per hour)

  46. What equality exists at long-run perfectly competitive equilibrium? P=MR=SRMC=SRATC=LRAC

  47. END

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