PERFECT COMPETITION

2. PERFECT COMPETITION • perfectly competitive market • A market with many sellers and • buyers of a homogeneous product • and no barriers to entry. • price taker • A buyer or seller that takes the market price as given.

3. PERFECT COMPETITION Here are the five features of a perfectly competitive market: 1 There are many sellers. 2 There are many buyers. 3 The product is homogeneous. 4 There are no barriers to market entry. 5 Both buyers and sellers are price takers.

4. Extra Application 6 COFFEE WARS • Starbucks, the current heavyweight of the upscale coffee world with 8,600 stores, is being challenged by Dunkin’ Donuts. The doughnut chain currently maintains 4,400 stores but plans to open 10,000 more outlets by 2020. • Many of the upscale coffee houses, and their patrons, do not view Dunkin’ Donuts as competition. • Others indicated they prefer Dunkin’ Donuts coffee over Starbucks. • The new Dunkin’ Donuts outlets have a new image…more urban and upscale. • Can this market accommodate a new entrant? It is my belief that consumers buy the coffee and the atmosphere of the coffee house. Starbucks will view Dunkin’ Donuts as a competitive threat if the company believes they appeal to the same market. New entrants will push the supply curve to the right and result in a lower price. However, I believe Starbucks will attempt to reinforce its image as the upscale coffee house where higher income individuals should be seen. If this is the case, then the market is actually for coffee houses, and not coffee.

5. 6.1 PREVIEW OF THE FOUR MARKET STRUCTURES • firm-specific demand curve • A curve showing the relationship • between the price charged by a • specific firm and the quantity the firm can sell.

6. 6.1 PREVIEW OF THE FOUR MARKET STRUCTURES  FIGURE 6.1 Monopoly Versus Perfect Competition

7. 6.1 PREVIEW OF THE FOUR MARKET STRUCTURES

8. 6.2 THE FIRM’S SHORT-RUN OUTPUT DECISION The Total Approach: Computing Total Revenue and Total Cost

9. 6.2 THE FIRM’S SHORT-RUN OUTPUT DECISION The Total Approach: Computing Total Revenue and Total Cost ► FIGURE 6.2 Using the Total Approach to Choose an Output Level

10. 6.2 THE FIRM’S SHORT-RUN OUTPUT DECISION The Marginal Approach • marginal revenue • The change in total revenue from • selling one more unit of output. marginal revenue = price To maximize profit, produce the quantity where price = marginal cost

11. 6.2 THE FIRM’S SHORT-RUN OUTPUT DECISION The Marginal Approach  FIGURE 6.3 The Marginal Approach to Picking an Output Level

12. 6.2 THE FIRM’S SHORT-RUN OUTPUT DECISION Economic Profit and the Break-Even Price economic profit = (price − average cost) × quantity produced • break-even price • The price at which economic profit is • zero; price equals average total cost.

13. 6.3 THE FIRM’S SHUT-DOWN DECISION Total Revenue, Variable Cost, and the Shut-Down Decision operate if total revenue > variable cost shut down if total revenue < variable cost

14. 6.3 THE FIRM’S SHUT-DOWN DECISION Total Revenue, Variable Cost, and the Shut-Down Decision ► FIGURE 6.4 The Shut-Down Decision and the Shut-Down Price

15. 6.3 THE FIRM’S SHUT-DOWN DECISION The Shut-Down Price operate if price > average variable cost shut down if price < average variable cost • shut-down price • The price at which the firm is • indifferent between operating and • shutting down; equal to the minimum • average variable cost.

16. 6.3 THE FIRM’S SHUT-DOWN DECISION Fixed Costs and Sunk Costs • sunk cost • A cost that a firm has already paid or • committed to pay, so it cannot be • recovered.

17. THE BREAK-EVEN PRICE FOR A CORN FARMER APPLYING THE CONCEPTS #1:What is the break-even price? To illustrate the notions of break-even and shut-down prices, let’s look at these prices for the typical corn farmer. • The break-even, or zero-profit, price is $0.72 per bushel. • At this price, the farmer will produce at the minimum point of the average total-cost curve, with the average cost equal to the market price of $0.72. • At a higher price, the farmer will make a positive economic profit. • The corn farmer’s shut-down price is $0.44. • At a price between the shut-down price ($0.44) and the break-even price ($0.72), the farmer will lose money but will continue to operate at a loss because total revenue will exceed the variable cost of growing corn. In the long run, farmers will exit the market if the price stays below the break-even price of $0.72.

18. 6.4 SHORT-RUN SUPPLY CURVES The Firm’s Short-Run Supply Curve • short-run supply curve • A curve showing the relationship • between the market price of a • product and the quantity of output • supplied by a firm in the short run.

19. 6.4 SHORT-RUN SUPPLY CURVES The Firm’s Short-Run Supply Curve  FIGURE 6.5 Short-Run Supply Curves

20. 6.4 SHORT-RUN SUPPLY CURVES The Short-Run Market Supply Curve • short-run market supply curve • A curve showing the relationship • between market price and the • quantity supplied in the short run.

21. 6.4 SHORT-RUN SUPPLY CURVES Market Equilibrium  FIGURE 6.6 Market Equilibrium

22. 6.4 SHORT-RUN SUPPLY CURVES Market Equilibrium • For a short-run equilibrium, two conditions are satisfied: • 1 At the market level, the quantity of the product supplied equals the quantity demanded. The demand curve intersects the short-run market supply curve at a price of $7 and a quantity of 600 shirts per minute (Panel A). • 2 The typical firm in the market maximizes its profit, given the market price. Given the market price of $7, each of the 100 firms maximizes profit by producing 6 shirts per minute (Panel B). • The market reaches a long-run equilibrium when the two conditions for short-run equilibrium are met, and a third long-run condition holds as well. • 3 Each firm in the market earns zero economic profit, so there is no incentive for existing firms to leave the market and no incentive for other firms to enter the market.

23. WIRELESS WOMEN IN PAKISTAN APPLYING THE CONCEPTS #2:How do entry costs affect the number of firms in a market? In Pakistan, many poor villagers cannot afford their own phones, and phone service is provided by thousands of “wireless women,” entrepreneurs who invest $310 in wireless phone equipment (transceiver, battery, charger), a signboard, a calculator, and a stopwatch. • They sell phone service to their neighbors, charging by the minute and second. • On average, their net income is about $2 per day, about three times the average per capita income in Pakistan. The market for phone service has the features of a perfectly competitive market, with easy entry, a standardized good, and a large enough number of suppliers that each takes the market price as given. In contrast, to enter the phone business in the United States, your initial investment would be millions, or perhaps billions, of dollars, so the market for phone service is not perfectly competitive.

24. 6.5 THE LONG-RUN SUPPLY CURVE FOR ANINCREASING-COST INDUSTRY • long-run market supply curve • A curve showing the relationship • between the market price and • quantity supplied in the long run. • increasing-cost industry • An industry in which the average cost of production increases as the total output of the industry increases; the long-run supply curve is positively sloped.

25. Extra Application 7 ORACLE’S QUEST FOR GREATER EFFICIENCY • Oracle Corporation’s recent takeover of rival Siebel Systems Inc. has spurred substantial job cuts. Oracle is expected to cut between 1,000 and 2,000 jobs that are primarily in functional areas that represent duplication of efforts. Oracle currently employs 51,000 original Oracle employees and the additional 4,700 Siebel employees. • The reduction in work force could cost some Oracle employees their jobs as the company attempts to boost profits via the downsizing. • The company’s cost-cutting moves are an attempt to compete with rival SAP in business application software. • Shareholders are not overly impressed with Oracle stock closing only 20 cents a share higher after the announcement. Oracle Corporation’s acquisition of Siebel has allowed the software firm to reduce average total costs via reduction in labor force. Many jobs in the now-merged company had substantial overlap and Oracle can reduce costs by eliminating duplicate positions. Oracle’s total output will be higher but the long-run average cost per unit should decline. Oracle will benefit from additional economies of scale as production and costs move from point a to point b.

26. 6.5 THE LONG-RUN SUPPLY CURVE FOR ANINCREASING-COST INDUSTRY • The average cost increases as the industry grows for two reasons: • Increasing input price. As an industry grows, it competes with other industries for limited amounts of various inputs, and this competition drives up the prices of these inputs. • 2 Less productive inputs. A small industry will use only the most productive inputs, but as the industry grows, firms may be forced to use less productive inputs.

27. 6.5 THE LONG-RUN SUPPLY CURVE FOR ANINCREASING-COST INDUSTRY Production Cost and Industry Size

28. 6.5 THE LONG-RUN SUPPLY CURVE FOR ANINCREASING-COST INDUSTRY Drawing the Long-Run Market Supply Curve  FIGURE 6.7 Long-Run Market Supply Curve

29. 6.6 SHORT-RUN AND LONG-RUN EFFECTSOF CHANGES IN DEMAND The Short-Run Response to an Increase in Demand  FIGURE 6.8 Short-Run Effects of an Increase in Demand

30. 6.6 SHORT-RUN AND LONG-RUN EFFECTSOF CHANGES IN DEMAND The Long-Run Response to an Increase in Demand  FIGURE 6.9 Short-Run and Long-Run Effects of an Increase in Demand

31. ZONING, LAND PRICES, AND THE SUPPLY CURVE FOR APARTMENTS APPLYING THE CONCEPTS #5:When input prices increase with the total output of the industry, what are the implications for the market supply curve? In many communities, the rental-apartment industry is an increasing-cost industry. As the industry expands by building more apartments, competition is fierce among firms for the small amount of land zoned for apartments. What are the implications of zoning for a market that experiences an increase in demand? In the short run, the stock of housing is fixed. An increase in demand for apartments will increase the price of apartments (the monthly rent), and firms will convert some owner-occupied houses to rental apartments. In the long run, firms will enter the market by building more apartments. The increase in demand leads to a net increase in price because zoning restricts the supply of apartment land, leading to higher land prices and a higher cost of producing apartments.

32. 6.7 LONG-RUN SUPPLY FOR ACONSTANT-COST INDUSTRY • constant-cost industry • An industry in which the average cost • of production is constant; the long-run supply curve is horizontal.

33. 6.7 LONG-RUN SUPPLY FOR ACONSTANT-COST INDUSTRY Long-Run Supply Curve for a Constant-Cost Industry  FIGURE 6.10 Long-Run Supply Curve for a Constant-Cost Industry

34. 6.7 LONG-RUN SUPPLY FOR ACONSTANT-COST INDUSTRY Hurricane Andrew and the Price of Ice ► FIGURE 6.11 Hurricane Andrew and the Price of Ice