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Chapter 9 Perfect Competition

Chapter 9 Perfect Competition. 9.1 The Characteristics of Perfect Competition. What is market 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.

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Chapter 9 Perfect Competition

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  1. Chapter 9Perfect Competition

  2. 9.1 The Characteristics of Perfect Competition • What is market 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

  3. What is perfect competition? The firm is a price taker – determined outside the firm 1. many small firms 2. homogeneous (same) product 3. very easy entry and exit 4. Perfect market information (prices, innovations etc…)

  4. What does homogeneous mean? • Goods that cannot be distinguished from one another; • for example, one potato cannot be distinguished from another potato

  5. What is a price taker? • A seller that has no control over the price of the product it sells eg. everyone undercuts prices

  6. The Demand PC Curve • What determines industry price? • Supply and Demand

  7. The Demand PC Curve • What determines the individual firm’s demand curve? • A horizontal line at the market price Industry Perfectly Competitive P P S PE PCDemand D Q Q

  8. Why is this horizontal line the firm’sdemand 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 because it can sell everything it brings to market at the market price

  9. 9.2 Determinants of Outputs and Profits in the Short-Run • What does the perfectly competitive firm control? • The only thing it controls is how many units it produces • The number of units whereby it will maximize its profits, or at least minimize its losses

  10. What are the two methods used todetermine how many units to produce? • TR and TC Where, TR = P x Q TC = C x Q • Using the total revenue - total cost method, where should a firm produce? • Where the distance between TR and TC is the greatest

  11. What are the two methods used todetermine how many units to produce? 1. TR and TC Where, TR = P x Q • Using the total revenue - total cost method, where should a firm produce? • Where the distance between TR and TC is the greatest Another way to get price: AR = TR/Q = QxP/Q = P

  12. What are the two methods used todetermine how many units to produce? TR TC

  13. What are the two methods used todetermine how many units to produce? 2. MR and MC • What is marginal revenue? Change in TR from one more unit of production MR = TR / 1 output • What is marginal cost? MC = TC / 1 output

  14. What are the two methods used todetermine how many units to produce? 2. MR and MC • Using the marginal revenue and marginal cost method, where should a firm produce? • MR = MC • BUT in a PC market the firm is a price taker…so the revenue s/he gets is determined by the horizontal demand curve: • P = MR = PCDemand

  15. When are Profits Maxed? • Add MC curve to the graph • At pt. A: MC(A) < MR(B) so can produce more to get more profit • Continue to produce until pt. C where MR=MC Perfectly Competitive P MC ATC B C MR = Pc = D E F A Q

  16. When are SR Profits Maxed? • Pts. DCEF is the area where profit is maximized in the Short Run • As long as ATC is below MR • In LR ATC moves up so profits = ZERO Perfectly Competitive P MC ATC B C MR = Pc = D E F A Q

  17. Minimizing Losses in the SR What happens with a price drop?? • Should the business shut-down? • Shut-down: stays in business but produces zero output -Avoids variable costs because it produces nothing -Still pays fixed costs like rent -Always stay in business if MR (P) > AVC

  18. Minimizing Losses in the SR What happens with a price drop?? Perfectly Competitive P MC ATC B C AVC F E MR = Pc = D A

  19. Minimizing Losses in the SR • Calculating the SR Breakeven Price • At what point do you shut down? the BE Price where MR = Lowest ATC pt. B and TR = TC • pt. B there are no econ profits but +ive acctg • pt C is SR shut down price Perfectly Competitive P MC ATC B AVC MR = Pc = D1 MR = Pc = D2 C

  20. 9.3 The SR Supply and Equilibrium • The firm’s marginal cost curve above the minimum point on its average variable cost curve Perfectly Competitive P MC = Supply ATC AVC MR = Pc = D A

  21. The SR Industry Supply Curve • The summation of the individual firm’s MC curves that lie above their minimum AVC points • Qty firm is willing to supply at every price • The Law of Diminishing Returns makes MC rise Perfectly Competitive P MC1 Si = SUM of MC MC2 MR = P6 = D AVC AVC MR = P5 = D 21 9 17 7 10 12

  22. Factors that influence the Industry Supply Curve • Anything that influences the MC curve influences the industry supply curve • What changes VC for the individual MC curve will shift the industry MC (supply) curve • eg. Productivity, factor costs like wages, taxes

  23. SR Equilibrium for the Industry • The horizontal sum of MR1 + MR2 = Si • The industry demand curve is the horizontal sum of all consumer demand curves P Di Si = SUM of MC Pe 21

  24. SR Equilibrium for the Industry and Firm • As long as P1 is above the min pt of ATC “a” then the firm is making a profit (shaded area) Industry (10 firms) Firm P P Di MC1 ATC1 P1 = D = MR Pe a Si = SUM of MC 10 firms in industry 21 2.1 Q Q

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