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Chapter 9... (cont.). Price and Output Under Perfect Competition. The Chapter.
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Chapter 9... (cont.) Price and Output Under Perfect Competition
The Chapter • Basically in this chapter, we are bringing together the theory of consumer behaviour and demand (the demand side of the economy), and the theory of production and costs (the supply side of the economy) together to analyze how price and output are determined in the market.
Markets • Where the interaction between economic agents (consumers, firms and resource owners) come together to realize their economic transactions.
Market Structure In Economics, market can generally be identified into four different types as follows: • Perfect Competition • Monopolistic Competition • Oligopoly • Monopoly
Figure 9.5 Short-Run Supply Curve of the Firm and Industry The left panel reproduces the firm’s MC curve above point Z (the shut down point) from Figure 8.4. This is the perfectly competitive firm’s short-run supply curve s. For example, at P = $25, Q = 3 (point C); at P = $35, Q = 3.5 (point E); at P = $50, Q = 4 (point T). The right panel shows the industry’s short-run supply curve on the assumption that there are 100 identical firms in the industry and input prices are constant. This is given by the SMC = S curve. Thus, at P = $25, Q = 300 (point C*); at P = $35, Q = 350 (point E*); at P = $50, Q = 400 (point T*).
Figure 9.8 Short-Run Equilibrium of the Firm and Industry With S (from Figure 9.5) and D in the right panel, P = $35 and Q = 350 (point E*), and the perfectly competitive firm would produce 3.5 units (point E in the left panel, as in Figure 9.3). If D shifted up to D¢, P = $50 and Q = 400 (point T*), and the firm would produce 4 units of output (point T in the left panel).
Figure 9.9 Long-Run Equilibrium of the Firm At P = MR = $35, the firm is in short-run equilibrium at point E (as in Figure 9.3). In the long run, the firm can increase its profits by producing at point J’, where P or MR = LMC (and LMC is rising), and operating plant SATC5 at point J. In the long-run, the firm will Make profits of $22 (J’J) per unit and $286 in total ($22 times 13 units of output). Since at point J’, P = MR = SMC = LMC, the firm is also in short- run equilibrium.
Figure 9. 10Long-Run Equilibrium of the Industry and Firm The industry (in the right panel) and the firm (in the left panel) are in long-run equilibrium at point H, where P = MR = SMC = LMC = SATC = LAC = $10. The firm produces at the lowest point on its LAC curve (operating optimal plant SATC4 at point H) and earns zero profits.
Figure 9.11 Constant Cost Industry Point H is the original long-run equilibrium point of the industry and firm. An increase in D to D’results in P = $20, and all firms earn economic profits. As more firms enter the industry, S shifts to S’ and P = $10 if input prices remain constant. By joining points H and H²in the right panel, we derive horizontal long-run supply curve LS for the (constant cost) industry.
Figure 9.12 Increasing Cost Industry Point H is the original long-run equilibrium point of the industry and firm. An increase in D to D’ results in P = $20 and all firms earn economic profits. As more firms enter the industry, S shifts to S’ and P = $15 if input prices rise. By joining points H and H²in the right panel, we derive positively sloped long-run supply curve LS for the (increasing cost) industry.
Figure 9.13 Decreasing Cost Industry Points H and H’ are the same as in the preceding two figures. Starting from point H’, as more firms enter the industry, S shifts to S’ and P = $5 if input prices fall. By joining points H and H²in the right panel, we derive the negatively sloped long-run supply curve LS for the (decreasing cost) industry.
Figure 9.14 Consumption, Production, and Imports Under Free Trade In the absence of trade, equilibrium is at point E, where Dx and Sx intersect, so that Px = $5 And Qx = 400. With free trade at the world price of Px = $3, domestic consumers purchase IR = 600X, of which IK = 200X are produced domestically and KR = 400X are imported.
Figure 9.15 Producer Surplus At Px = $5 the firm produces 4X (point E). Since the marginal cost is $2 on the first unit of X produced, the firm receives a surplus of $3 (given by the area of the first shaded rectangle). With MCx = $3 on the second unit of X, producer surplus is $2 (the area of the second shaded rectangle). With MCx = $4 on the third unit, producer surplus is $1 (the area of the third shaded rectangle). With MCx = $5 on the fourth unit, producer surplus is zero. Total producer surplus on 4X is $6. If commodity X were infinitesimally divisible, total producer surplus would be $8 (the area of triangle BEC).
Figure 9.16 The Efficiency of Perfect Competition Expanding output from 300X to 400X increases consumers’ plus producers’ surplus by HEJ = $100. Expanding output past the competitive equilibrium output of 400X reduces the total surplus, because the marginal benefit to consumers is less than the marginal cost of producers. Thus, consumers’ plus producers’ surplus is maximized when a perfectly competitive market is in equilibrium.
x Figure 9.17 Welfare Effects of an Excise Tax With Dx and Sx, equilibrium is at point E at which Px = $5 and Qx = 400. A tax of $2 per unit on commodity X shifts Sx up to S¢and defines new equilibrium point H at which Px = $6 to consumers, Qx = 300, and producers receive a net price of $4 per unit. The loss of consumers’ surplus is LHEB = $350, the loss of producers’ surplus is BEJN = $350, for a combined loss of LHEJN = $700. Since tax revenues are LHJN = $600 ($2 per unit on 300 units), there is a deadweight loss of HEJ = $100.
Figure 9.18 Effects of an Import Tariff Dxand Sxrepresent the domestic market demand and supply curves of commodity X. At the free trade price Px= $3, domestic consumers purchase IR = 600X, of which IK = 200X are produced domestically and KR = 400X are imported. With a $1 import tariff, Pxto domestic consumers rises to $4. At Px= $4, domestic consumers purchase NU = 500X, of which NJ = 300X are produced domestically and JU = 200X are imported. Thus, the consumption effect of the tariff is RW = –100X, the production effect is KV = 100X, the trade effect is RW + KV = –200X, and the revenue effect is JUWV = $200. Consumers’ surplus declines by NURI = $550, of which NJKI = $250 represents an increase in producers’ surplus, JUWV = $200 is the tariff revenue, and URW = $50 plus JKV = $50 represents the deadweight loss of the tariff.
Figure 9.19 The Foreign Exchange Market and the Dollar Exchange Rate The vertical axis measures the dollar price of euros (R = $/), and the horizontal axis measures the quantity of euros. Under a flexible exchange rate system, the equilibrium exchange rate is R = 1 and the equilibrium quantity of euros bought and sold is 300 million per day. This is given by point E, at which the U.S. demand and supply curves for euros intersect.
