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Chapter 10

Chapter 10. The Firm and the Industry under Perfect Competition.

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Chapter 10

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  1. Chapter 10 The Firm and the Industry under Perfect Competition Competition . . . brings about the only . . . arrangement of social production which is possible. . . [Otherwise] what guarantee [do] we have that the necessary quantity and not more of each product will be produced, that we shall not go hungry in regard to corn and meat while we are choked in beet sugar and drowned in potato spirit, that we shall not lack trousers to cover our nakedness while buttons flood us in millions? FRIEDRICH ENGELS

  2. Perfect Competition Defined • Perfect competition • Numerous small firms & consumers • Homogeneity of product • Freedom of entry and exit • Perfect information

  3. The Perfectly Competitive Firm • Perfectly competitive firm • No choice • Accept market price • “Price taker” • Horizontal demand curve • Sell as much as it wants • At market price • Price • Industry supply • Industry demand

  4. Figure 1 Demand curve for a firm under perfect competition S D $3 $3 Industry supply curve Industry demand curve Firm’s demand curve Price per Bushel in Chicago E A C B D S 0 0 100 1 200 2 300 3 400 4 Total Sales in Chicago in Thousands of Truckloads per Year Truckloads of Corn Sold by Farmer Jasmine per Year (b) (a)

  5. The Perfectly Competitive Firm • Short-run equilibrium • Choose quantity • Marginal cost = Marginal revenue • Firm’s demand - horizontal • Price (P) • Average revenue (AR) • Marginal revenue (MR) • P = AR = MR

  6. Figure 2 Short-run equilibrium of the perfectly competitive firm MC AC $3.00 D=MR=AR Revenue and Cost per Bushels 2.25 B 1.50 A 0 50,000 Bushels of Corn per Year

  7. Table 1 Revenues, costs, and profits of a perfectly competitive firm

  8. The Perfectly Competitive Firm • Profit – maximizing firm • Equilibrium • Quantity: MC = P = MR = AR • Total revenue TR = P ˣ Q • Total cost TC = AC ˣ Q • If P > AC (TR > TC) • Profit • Maximize profit

  9. The Perfectly Competitive Firm • If P < AC (TR < TC) • Loss • Minimize loss • Profit per unit: AR - AC • Average revenue (AR) • Average cost (AC)

  10. Figure 3 Short-run equilibrium of the perfectly competitive firm with a lower price MC AC D=MR=AR Revenue and Cost per Bushels $2.25 A 1.50 B 0 30,000 Bushels of Corn per Year

  11. The Perfectly Competitive Firm • Variable cost • Changes with quantity of output • If TR < TC: Loss • Shut down • Short-run • Or long-run • If TR > TVC (P > AVC) • Short-run: operate • If P < AVC: shut down • Quantity of output = 0

  12. Table 2 The shutdown decision

  13. Figure 4 Shutdown analysis MC AC AVC P3 P2 P1 P3 Price P2 P1 A B 0 Quantity supplied

  14. The Perfectly Competitive Firm • Firm’s supply curve • Different quantities of output • Willing to supply • Different possible prices • Given period of time • Short-run supply curve • Portion of marginal cost curve • Where P = AR = MR = MC • P: above minimum level of AVC

  15. The Perfectly Competitive Industry • Short-run • Fixed number of firms • Long-run • Firms: enter / exit • Adjust output

  16. The Perfectly Competitive Industry • Industry’s supply curve • Different quantities of output • Industry – supply • Different possible prices • Given period of time • Short run industry supply curve • Horizontally sum • All short-run supply curves • All firms

  17. Figure 5 Derivation of the industry supply curve from the supply curves of the individual firms S s Firm Industry $3.00 $3.00 Price per Bushel Price per Bushel 2.25 2.25 S s C c e E 0 0 45 45 50 50 Quantity Supplied in Millions of Bushels Quantity Supplied in Thousands of Bushels (b) (a)

  18. The Perfectly Competitive Industry • Short-run equilibrium • Industry supply curve • Market demand curve • Downward sloping • Equilibrium quantity • Equilibrium price

  19. Figure 6 Supply-demand equilibrium of a perfectly competitive industry S D $3.75 3.00 Price per Bushel 2.25 C A S E D 0 45 72 50 Quantity of Corn in Millions of Bushels

  20. The Perfectly Competitive Industry • Long-run equilibrium • Short-run economic profits • New firms enter industry • Industry short-run S curve – increase • Price – falls • Each firm – decrease output • Zero economic profit

  21. Figure 7 A shift in the industry supply curve caused by the entry of new firms S0 S1 (1,000 firms) (1,600 firms) D $3.00 Price per Bushel 2.25 A S0 E F D S1 0 72 50 80 Quantity of Corn in Millions of Bushels

  22. Figure 8 The perfectly competitive firm and the perfectly competitive industry S0 Firm Industry (1,000 firms) S1 (1,600 firms) AC MC D $3.00 D0 D1 Price per Bushel Price per Bushel 2.25 $3.00 2.25 S0 A E e a S1 D b 0 0 72 50 40 45 50 Quantity of Corn in Thousands of Bushels Quantity of Corn in Millions of Bushels (a) (b)

  23. Figure 9 Long-run equilibrium of the perfectly competitive firm and industry Firm Industry S2 (2,075 firms) AC MC Price per Bushel D Price per Bushel D2 $1.87 $1.87 A m S2 D 0 0 83 40 Quantity of Corn in Thousands of Bushels Quantity of Corn in Millions of Bushels (a) (b)

  24. The Perfectly Competitive Industry • Long-run equilibrium • Maximize profit • P = MC • New entry - price decrease • P tangent to firm’s long-run AC curve (P = AC) • P = MC = AC • Zero economic profit • Maximum sustainable

  25. The Perfectly Competitive Industry • Zero economic profit • Positive accounting profit • Break even • Economic profit • Net earnings • Minus opportunity cost • Inputs supplied by firm’s owners

  26. How much does it really cost? • Opportunity cost • Cost of firm’s owners capital/inputs • Included in AC curve • Break even • Zero economic profit • Cover all costs • Accounting • Opportunity costs

  27. The Perfectly Competitive Industry • Long-run industry supply curve • From short-run industry supply curve • Firms: enter / exit • Shift S curve • Cost curves • Long-run cost curves • Long-run industry average cost curve • Zero economic profit

  28. Figure 10 Short-run industry supply and long-run industry average cost S LRAC Price, Average Cost per Bushel $2.62 1.50 B S A 0 70 Output in Millions of Bushels of Corn

  29. Perfect Competition & Economic Efficiency • Long-run equilibrium • Each firm • Minimum point on AC curve • Lowest possible cost to society • Efficiency

  30. Table 3 Average cost for the firm and total cost for industry

  31. Figure 11 Taxes versus subsidies as incentives to cut pollution D T S X Price, Average Cost T S X E A B D 0 Qb Qa Qe Output

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