Transcript Chapter 24

Chapter 24
Perfect
Competition
Introduction
Why has the range of choices among providers
of digital photo printing services expanded so
much during the 2000s?
How has this expansion contributed to the
decline in the price of printed digital photos?
Does this expansion relate to the concept of
perfect competition?
In this chapter, you will find some answers.
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24-2
Learning Objectives
• Identify the characteristics of a perfectly
competitive market structure
• Discuss the process by which a
perfectly competitive firm decides how
much output to produce
• Understand how the short-run supply
curve for a perfectly competitive firm
is determined
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24-3
Learning Objectives (cont'd)
• Explain how the equilibrium price is
determined in a perfectly competitive market
• Describe what factors induce firms to enter or
exit a perfectly competitive industry
• Distinguish among constant-, increasing-,
and decreasing-cost industries based on the
shape of the long-run industry supply curve
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24-4
Chapter Outline
• Characteristics of a Perfectly Competitive
Market Structure
• The Demand Curve of the Perfect Competitor
• How Much Should the Perfect
Competitor Produce?
• Using Marginal Analysis to Determine the
Profit-Maximizing Rate of Production
• Short-Run Profits
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24-5
Chapter Outline (cont'd)
• The Short-Run Breakeven Price and the Short-Run
Shutdown Price
• The Supply Curve for a Perfectly
Competitive Industry
• Price Determination Under Perfect Competition
• The Long-Run Industry Situation: Exit and Entry
• Long-Run Equilibrium
• Competitive Pricing: Marginal Cost Pricing
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Did You Know That...
• In common speech, competition simply
means “rivalry?”
• Under extreme perfectly competitive
situations, individual buyers and sellers
cannot affect the market price?
• Economic profits that perfectly competitive
firms may earn for a time ultimately
disappear as other firms enter the industry?
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Characteristics of a Perfectly Competitive
Market Structure
• Perfect Competition
 A market structure in which the decisions
of individual buyers and sellers have no
effect on market price
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Characteristics of a Perfectly Competitive
Market Structure (cont'd)
• Perfectly Competitive Firm
 A firm that is such a small part of the total
industry that it cannot affect the price
of the product or service that it sells
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24-9
Characteristics of a Perfectly Competitive
Market Structure (cont'd)
• Price Taker
 A competitive firm that must take the price
of its product as given because the firm
cannot influence its price
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Characteristics of a Perfectly Competitive
Market Structure (cont'd)
• Why a perfect competitor is a
price taker
1. Large number of buyers and sellers
2. Homogenous products are
perfect substitutes
3. Buyers and sellers have equal access
to information
4. No barriers to entry or exit
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24-11
E-Commerce Example: A Monastery
Takes Advantage of Unhindered Entry
• When they discovered that they could
purchase generic printing supplies,
remanufacture printer ink cartridges,
and offer them for sale on the Internet,
a new business called Lasermonk.com
was born.
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24-12
E-Commerce Example:
A Monastery Takes Advantage of
Unhindered Entry (cont'd)
• By the mid-2000s, the business was
earning more than $3 million per year,
which the monastery uses to fund
activities ranging from computer
classes for orphans to food programs
for homeless children.
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The Demand Curve
of the Perfect Competitor
• Question
 If the perfectly competitive firm is a price
taker, who or what sets the price?
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24-14
Figure 24-1 The Demand Curve
for a Producer of Flash Memory Pen
Drives, Panel (a)
Neither an individual
buyer nor seller can
influence the price
The interaction of market
supply and demand yields
an equilibrium price of $5
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24-15
The Demand Curve
of the Perfect Competitor (cont'd)
• The perfectly competitive firm is a price
taker, selling a homogenous commodity
with perfect substitutes.
 Will sell all units for $5
 Will not be able to sell at a higher price
 Will face a perfectly elastic demand curve
at the going market price
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24-16
Figure 24-1 The Demand Curve for a
Producer of Flash Memory Pen Drives
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How Much Should the Perfect
Competitor Produce?
• Perfect competitor accepts price
as given
 Firm raises price, it sells nothing
 Firm lowers its price, it earns less
revenues than it otherwise would
• Perfect competitor has to decide how
much to produce
 Firm uses profit-maximization model
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How Much Should the Perfect
Competitor Produce? (cont'd)
• The model assumes that firms attempt
to maximize their total profits.
 The positive difference between total
revenues and total costs
• The model also assumes firms seek to
minimize losses.
 When total revenues may be less than
total costs
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24-19
How Much Should the Perfect
Competitor Produce? (cont'd)
• Total Revenues
 The price per unit times the total
quantity sold
 The same as total receipts from the sale
of output
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How Much Should the Perfect
Competitor Produce? (cont'd)
Profit
p = Total revenue (TR) – Total cost (TC)
TR = P x Q
TC = TFC + TVC
P determined by the market in perfect competition
Q determined by the producer to maximize profit
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Figure 24-2
Profit Maximization, Panel (a)
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Figure 24-2
Profit Maximization, Panel (b)
Total
Output/
Sales/ Total
day
Costs
Market
Price
Total
Revenue
Total
Profit
0
$10
$5
$0
$10
1
15
5
5
10
2
18
5
10
8
3
20
5
15
5
4
21
5
20
1
5
23
5
25
2
6
26
5
30
4
7
30
5
35
5
8
35
5
40
5
9
41
5
45
4
10
48
5
50
2
11
56
5
55
1
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How Much Should the Perfect
Competitor Produce? (cont'd)
• Profit-Maximizing Rate of Production
 The rate of production that maximizes total
profits, or the difference between total
revenues and total costs
 Also, the rate of production at which
marginal revenue equals marginal cost
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Figure 24-2
Profit Maximization, Panel (c)
Total
Output/
Sales/ Market
day
Price
0
$5
1
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
9
5
10
5
11
5
Marginal
Cost
Marginal
Revenue
$5
$5
3
5
2
5
1
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
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Using Marginal Analysis to Determine
the Profit-Maximizing Rate of Production
• Marginal Revenue
 The change in total revenues divided by
the change in output
• Marginal Cost
 The change in total cost divided by the
change in output
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24-26
Using Marginal Analysis to
Determine the Profit-Maximizing
Rate of Production (cont'd)
• Profit maximization occurs at the
rate of output at which marginal
revenue equals marginal cost.
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Short-Run Profits
• To find out what our competitive
individual flash memory producer is
making in terms of profits in the short
run, we have to determine the excess of
price above average total cost.
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24-28
Short-Run Profits (cont'd)
• From Figure 24-2 previously, if we
have production and sales of seven
flash drives, TR = $35, TC = $30, and
profit = $5.
• Now we take info from column 6 in
panel (a) and add it to panel (c) to get
Figure 24-3.
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Figure 24-3 Measuring Total Profits
• Profits are maximized where
MR = MC
• This occurs at Q = 7.5 units
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24-30
Short-Run Profits (cont'd)
• Graphical depiction of maximum profits
 The height of the rectangular box
represents profits per unit.
 The length represents the amount of
units produced.
 When we multiply these two quantities, we
get total economic profits.
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Figure 24-4
Minimization of Short-Run Losses
• Losses are minimized where
MR = MC
• This occurs at Q = 5.5 units
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24-32
Short-Run Profits (cont'd)
• Short-run average profits are
determined by comparing ATC with
P = MR = AR at the profit-maximizing Q.
• In the short run, the perfectly
competitive firm can make either
economic profits or economic losses.
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The Short-Run Shutdown Price
• What do you think?
 Would you continue to produce if you were
incurring a loss?
 In
the short run?
 In
the long run?
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24-34
The Short-Run
Shutdown Price (cont'd)
• As long as the loss from staying in
business is less than the loss from
shutting down, the firm will continue
to produce.
• A firm goes out of business when
the owners sell its assets; a firm
temporarily shuts down when it stops
producing, but is still in business.
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24-35
The Short-Run
Shutdown Price (cont'd)
• As long as the price per unit sold
exceeds the average variable cost
per unit produced, the earnings of
the firm’s owners will be higher if it
continues to produce in the short
run than if it shuts down.
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24-36
The Short-Run
Shutdown Price (cont'd)
• Short-Run Break-Even Price
 The price at which a firm’s total revenues equal its
total costs
 At the break-even price, the firm is just making a
normal rate of return on its capital investment (it’s
covering its explicit and implicit costs).
• Short-Run Shutdown Price
 The price that just covers average variable costs
 It occurs just below the intersection of the
marginal cost curve and the average variable
cost curve.
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24-37
Figure 24-5 Short-Run Shutdown
and Break-Even Prices
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24-38
The Meaning of
Zero Economic Profits
• Question
 Why produce if you are not making
a profit?
• Answer
 Distinguish between economic profits and
accounting profits.
 Remember when economic profits are
zero a firm can still have positive
accounting profits.
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24-39
The Supply Curve for a Perfectly
Competitive Industry
• Question
 What does the short-run supply curve for
the individual firm look like?
• Answer
 The firm’s short-run supply curve is its
marginal cost curve at and above the point
of intersection with the average variable
cost curve.
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24-40
Figure 24-6 The Individual Firm’s
Short-Run Supply Curve
• Given the price, the
quantity is determined
where MC = MR
• Short-run supply = MC
above minimum AVC
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24-41
The Supply Curve for a Perfectly
Competitive Industry (cont'd)
• The Industry Supply Curve
 The locus of points showing the
minimum prices at which given
quantities will be forthcoming
 Also called the market supply curve
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24-42
Figure 24-7
Deriving the Industry Supply Curve
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24-43
The Supply Curve for a Perfectly
Competitive Industry (cont'd)
• Factors that influence the industry
supply curve (determinants of supply)
 Firm’s productivity
 Factor costs
 Wages, prices of raw materials
 Taxes and subsidies
 Number of sellers
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24-44
Price Determination Under
Perfect Competition
• Question
 How is the market, or “going,” price
established in a competitive market?
• Answer
 This price is established by the
interaction of all the suppliers (firms)
and all the demanders.
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24-45
Price Determination Under
Perfect Competition (cont'd)
• The competitive price is determined by
the intersection of the market demand
curve and the market supply curve.
 The market supply curve is equal to the
horizontal summation of the supply curves
of the individual firms.
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24-46
Figure 24-8 Industry Demand and
Supply Curves and the Individual Firm
Demand Curve, Panel (a)
Pe is the price
the firm must take
Pe and Qe determined by
the interaction of the
industry S and market D
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24-47
Figure 24-8 Industry Demand and
Supply Curves and the Individual Firm
Demand Curve, Panel (b)
• Given Pe, firm produces qe where MC = MR
 If AC = AC1, break-even
• If AC = AC2, losses
• If AC = AC3, economic profit
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24-48
The Long-Run Industry Situation:
Exit and Entry
• Profits and losses act as signals for
resources to enter an industry or to
leave an industry.
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24-49
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Signals
 Compact ways of conveying to economic
decision makers information needed to
make decisions
 An effective signal not only conveys
information but also provides the incentive
to react appropriately.
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24-50
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Exit and entry of firms
 Economic profits
 Signal
resources to enter the market
 Economic losses
 Signal
resources to exit the market
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24-51
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Allocation of capital and market signals
 Price system allocates capital according to
the relative expected rates of return on
alternative investments.
 Investors and other suppliers of resources
respond to market signals about their
highest-valued opportunities.
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24-52
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Tendency toward equilibrium (note that
firms are adjusting all of the time)
 At break-even, resources will not enter or
exit the market.
 In competitive long-run equilibrium, firms
will make zero economic profits.
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24-53
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Long-Run Industry Supply Curve
 A market supply curve showing the
relationship between prices and quantities
after firms have been allowed time to enter
or exit from an industry, depending on
whether there have been positive or
negative economic profits
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24-54
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Constant-Cost Industry
 An industry whose total output can be
increased without an increase in long-run
per-unit costs
 Its long-run supply curve is horizontal.
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24-55
Figure 24-9 Constant-Cost,
Increasing-Cost, and Decreasing-Cost
Industries, Panel (a)
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24-56
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Increasing-Cost Industry
 An industry in which an increase in
industry output is accompanied by an
increase in long-run per unit costs
 Its long-run industry supply curve
slopes upward.
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24-57
Figure 24-9 Constant-Cost,
Increasing-Cost, and Decreasing-Cost
Industries, Panel (b)
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24-58
The Long-Run Industry Situation:
Exit and Entry (cont'd)
• Decreasing-Cost Industry
 An industry in which an increase in
industry output leads to a reduction in
long-run per-unit costs
 Its long-run industry supply curve
slopes downward.
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24-59
Figure 24-9 Constant-Cost,
Increasing-Cost, and Decreasing-Cost
Industries, Panel (c)
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24-60
Example: Decreasing Costs and the
Market for Transistors
• Since the late 1960s, the annual production
of transistors has expanded from 1 billion to
1 quintillion.
• At the same time, the cost per unit has
dropped from about $1 to a miniscule
fraction of a penny.
• Transistor production serves as a good
illustration of a decreasing-cost industry.
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24-61
Figure 24-10 World Transistor
Production and Prices Since 1968
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24-62
Long-Run Equilibrium
• In the long run, the firm can change the scale
of its plant, adjusting its plant size in such a
way that it has no further incentive to change;
it will do so until profits are maximized.
• In the long run, a competitive firm produces
where price, marginal revenue, marginal
cost, short-run minimum average cost, and
long-run minimum average cost are equal.
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24-63
Figure 24-11 Long-Run Firm
Competitive Equilibrium
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24-64
Competitive Pricing:
Marginal Cost Pricing
• Marginal Cost Pricing
 A system of pricing in which the price
charged is equal to the opportunity cost to
society of producing one more unit of the
good or service in question
 The opportunity cost is the marginal cost
to society.
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24-65
Competitive Pricing:
Marginal Cost Pricing (cont'd)
• Market Failure
 A situation in which an unrestrained market
operation leads to either too few
or too many resources going to a specific
economic activity
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24-66
Issues and Applications: The Big Rush to
Provide Digital Snaps in a Snap
• The photography industry brings in about
$85 billion in revenues each year.
• Since 2000, the majority of those revenues
have been earned from the sale of digital
cameras and related digital photography
products and services.
• During the mid-2000s, a rapidly growing part
of the digital photography business has been
the market for digital photo printing services.
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24-67
Issues and Applications: The Big Rush to
Provide Digital Snaps in a Snap (cont'd)
• The demand for digital photo printing services
increased, and the market clearing price rose from
15 to about 19 cents.
• Numerous firms entered the industry causing market
supply to increase and the market clearing price
declined from 19 cents to about 12 cents.
• Hence, the long-run supply curve in this industry
sloped downward, indicating that this is a
decreasing-cost industry.
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24-68
Figure 24-12 Short-Run and
Long-Run Adjustments in the Digital
Photo Printing Industry
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24-69
Summary Discussion
of Learning Objectives
• The characteristics of a perfectly
competitive market structure
1. Large number of buyers and sellers
2. Homogeneous product
3. Buyers and sellers have equal access
to information
4. No barriers to entry and exit
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24-70
Summary Discussion
of Learning Objectives (cont'd)
• How a perfectly competitive firm
decides how much to produce
 Economic profits are maximized when
marginal cost equals marginal revenue as
long as the market price is not below the
short-run shutdown price, where the
marginal cost curve crosses the average
variable cost curve.
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24-71
Summary Discussion
of Learning Objectives (cont'd)
• The short-run supply curve of a
perfectly competitive firm
 The rising part of the marginal cost curve
above minimum average variable cost
• The equilibrium price in a perfectly
competitive market
 A price at which the total amount of output
supplied by all firms is equal to the total
amount of output demanded by all buyers
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24-72
Summary Discussion
of Learning Objectives (cont'd)
• Incentives to enter or exit a perfectly
competitive industry
 Economic profits induce entry of new firms.
 Economic losses will induce firms to exit
the industry.
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24-73
Summary Discussion
of Learning Objectives (cont'd)
• The long-run industry supply curve and constant-,
increasing-, and decreasing-cost industries
 The relationship between price and quantity after firms have
been able to enter or exit the industry
 Constant-cost industry

Horizontal long-run supply curve
 Increasing-cost industry

Upward-sloping long-run supply curve
 Decreasing-cost industry

Downward-sloping long-run supply curve
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24-74
End of
Chapter 24
Perfect
Competition