ECON107 Principles of Microeconomics Week 13 DECEMBER 2013

1. Chapter-12 ECON107Principles of MicroeconomicsWeek 13DECEMBER 2013

2. 12 PERFECT COMPETITION

3. Lesson Objectives • Define perfect competition • How perfect competition arises • Explain how a firm makes its output decision • Explain how price and output are determined in perfect competition

4. Perfect Competition • Perfect competition is a market in which • Many firms sell identical products to many buyers (Standardized Product). • There are no restrictions to entry into the industry (Free Entry and Exit). • Established firms have no advantages over new ones (Price Takers). • Sellers and buyers are well informed about prices.

5. How Perfect Competition Arises • Perfect competition arises when: • the firm’s minimum efficient scale is small relative to market demand so there is room for many firms in the market. • each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care which firm’s good they buy.

6. Perfect Competition A price taker is a firm that cannot influence the price of a good or service. • No single firm can influence the price—it must “take” the equilibrium market price. • Each firm’s output is a perfect substitute for the output of the other firms, so the demand for each firm’s output is perfectly elastic.

7. Goals of Perfectly Competitive firm • The goal of each competitive firm is to maximize economic profit, which equals total revenue minus total cost.

8. SHORT RUN PROFIT MAXIMIZATION Two Approaches... First: Total-Revenue -Total Cost Approach Second: Marginal-Revenue -Marginal Cost Approach • The Decision Process: • Should the firm produce (Whether to enter or exit a market)? • What quantity should be produced? • What profit or loss will be realized (How to produce at minimum cost)? The Decision Rule: Produce in the short-run if it can realize 1- A profit (or) 2- A loss less than its fixed costs

9. ] ] ] ] ] ] ] ] ] ] DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER Product Price (P) (Average Revenue) Quantity Demanded (Q) Total Revenue (TR) Marginal Revenue (MR) $131 131 131 131 131 131 131 131 131 131 131 0 1 2 3 4 5 6 7 8 9 10 $ 0 131 262 393 524 655 786 917 1048 1179 1310 $131 131 131 131 131 131 131 131 131 131

10. TR 1179 1048 917 786 655 524 393 262 131 0 Price and revenue D = MR 1 2 3 4 5 6 7 8 9 10 Quantity Demanded (sold)

11. Can you see the profit maximization? TOTAL REVENUE-TOTAL COST APPROACH Total Fixed Cost Total Variable Cost Price: $131 Total Product Total Cost Total Revenue Profit 0 1 2 3 4 5 6 7 8 9 10 $ 100 100 100 100 100 100 100 100 100 100 100 $ 0 90 170 240 300 370 450 540 650 780 930 $ 100 190 270 340 400 470 550 640 750 880 1030 $ 0 131 262 393 524 655 786 917 1048 1179 1310 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280

12. Break-Even Point (Normal Profit) $1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100 0 Total Revenue Maximum Economic Profits $299 Total revenue and total cost Total Cost Break-Even Point (Normal Profit) 1 2 3 4 5 6 7 8 9 10 11 12 13 14

13. Second: Marginal-Revenue -Marginal Cost Approach Profit is maximized by producing the output at which marginal revenue (MR), equals marginal cost (MC). MR = MC Rule

14. Average Fixed Cost Average Variable Cost Average Total Cost Price = Marginal Revenue Total Economic Profit/Loss Total Product Marginal Cost Graphically 0 1 2 3 4 5 6 7 8 9 10 $100.00 50.00 33.33 25.00 20.00 16.67 14.29 12.50 11.11 10.00 $90.00 85.00 80.00 75.00 74.00 75.00 77.14 81.25 86.67 93.00 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00 90 80 70 60 70 80 90 110 130 150 $ 131 131 131 131 131 131 131 131 131 131 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280

15. If MR > MC, economic profit increases if output increases. $200 150 100 50 0 Economic Profit MC If MR < MC, economic profit decreases if output increases. $131.00 MR Cost and Revenue ATC $97.78 AVC If MR = MC, economic profit decreases if output changes in either direction, so economic profit is maximized. 1 2 3 4 5 6 7 8 9 10

16. Second: Marginal-Revenue -Marginal Cost Approach • A firm’s shutdown point is the point at which it is indifferent between producing and shutting down. • This point is where AVC is at its minimum. • It is also the point at which the MC curve crosses the AVC curve.

17. Figure shows the shutdown point. • Minimum AVC is $17 a sweater. • If the price is $17, the profit-maximizing output is 7 sweaters a day. • The firm incurs a loss equal to the red rectangle. • If the price of a sweater is between $17 and $20.14, the firm produces the quantity at which marginal cost equals price. • The firm covers all its variable cost and at least part of its fixed cost. • It incurs a loss that is less than TFC.

18. Output, Price, and Profit in the Short Run • Market Supply in the Short Run • The short-run market supply curve shows the quantity supplied by all firms in the market at each price when each firm’s plant and the number of firms remain the same.

19. Output, Price, and Profit in the Short Run Break-even (Normal Profit) Point MC MR5 P5 ATC MR4 P4 Cost and Revenue, (dollars) AVC MR3 P3 MR2 P2 MR1 P1 Do not Produce – Below AVC Q2 Q3 Q4 Q5 Quantity Supplied

20. Output, Price, and Profit in the Short Run Yields the Short-Run Supply Curve Supply MC MR5 P5 MR4 P4 Cost and Revenue, (dollars) MR3 P3 MR2 P2 MR1 P1 No Production Below AVC Q2 Q3 Q4 Q5

21. At a price equal to minimum AVC, the shutdown price, some firms will produce the shutdown quantity and others will produces zero. • The market supply curve is perfectly elastic. Short-Run Equilibrium • Short-run market supply and market demand determine the market price and output. • Figure shows a short-run equilibrium.

23. Now it’s over for today. Do you have any question?