Transcript Perfect Competition - Widener University

Types of Market Structure
• Pure Competition or Perfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly
Perfect Competition
Assumptions
of Perfect Competition
• Many independent firms
• Each seller is small relative to the whole market
• Homogeneous (identical) product
• Easy entry and exit (no barriers to entry)
Price Taking
The perfectly competitive firm is said to be a
price-taker, because it takes the market price
as given and has no control over the price.
Why?...
If the firm tried to charge a higher price, it
would lose all its business. Customers could
go elsewhere to buy the same product for less.
Since the firm is very small, it can sell as
much as it wants at the market price. So
there’s no reason to charge a lower price.
The demand curve for the product of the
perfectly competitive firm shows how much
can be sold at specific prices. Let’s see what
it would look like...
The firm can sell as little or as much as it
wants at the market price. Suppose, for
example, the market price is $5.
The firm can sell 10 units for $5.
price
$5
10
quantity
The firm can sell 20 units for $5.
price
$5
20
quantity
The firm can sell 30 units for $5.
price
$5
30
quantity
The firm can sell 40 units for $5.
price
$5
40
quantity
The firm can sell 50 units for $5.
price
$5
50 quantity
So all these points are on the demand
curve for the firm’s product.
price
$5
quantity
Connecting these points, we have the
demand curve for the firm’s product.
price
$5
demand
quantity
The demand curve for the perfectly
competitive firm’s product is a
horizontal line at the market price.
price
market price
demand
quantity
Recall: Total Revenue
Total Revenue = Price x Quantity
TR = P Q
Recall: Marginal Revenue (MR)
Marginal Revenue is the additional revenue
earned from selling one additional unit of
output.
MR = DTR / DQ
comment
For ease of writing, instead of writing the
“perfectly competitive” firm we will
frequently write the “p.c.” firm.
The MR Curve
for the p.c. Firm
For the p.c. firm, MR is equal to the market price.
So MR is a horizontal line at the level of that price.
The demand curve for the p.c. firm is also a
horizontal line at the level of the market price. So,
for the p.c. firm, the demand curve and the MR
curve are the same horizontal line.
The demand curve (D) and the MR
curve for the perfectly competitive
firm’s product.
price
market price
D = MR
quantity
Optimal Output Level
Recall:
To maximize profit, the firm will produce at
the output level where MR = MC.
So the firm will produce where the MR and
MC curves intersect.
Draw your axes; label them quantity and $.
$
Quantity
Draw your ATC, AVC, and MC curves. (Make sure
MC intersects ATC and AVC at the minimum.)
$
ATC
AVC
MC
Quantity
Draw the D = MR curve horizontal
at the market price.
$
D = MR
ATC
AVC
MC
Quantity
If the market price is P1 ,
the quantity produced will be Q1.
$
D = MR
P1
ATC
AVC
MC
Q1
Quantity
If the market price is P2 ,
the quantity produced will be Q2.
$
ATC
D = MR
P2
AVC
MC
Q2
Quantity
If the market price is P3 ,
the quantity produced will be Q3.
$
ATC
P3
AVC
D = MR
MC
Q3
Quantity
If the market price is P4 ,
the quantity produced will be Q4.
$
ATC
P4
AVC
D = MR
MC
Q4
Quantity
If the market price is P5 ,
the quantity produced will be Q5.
$
ATC
AVC
D = MR
P5
MC
Q5
Quantity
Price P5 was the minimum of the AVC curve
(the shutdown point). If the price fell any
lower than P5 the firm would produce no
output.
The p.c. firm’s short run supply curve
The firm’s supply curve shows the quantity the firm
will produce at each price.
The P, Q values we have shown, therefore, are
points on the firm’s supply curve.
But those points are all on the firm’s MC curve.
So, the firm’s supply curve is the part of the MC
curve that is above the minimum of the AVC curve.
The p.c. firm’s short run supply curve
Supply
$
ATC
AVC
MC
Quantity
The market short run supply curve
To determine the total amount that all the
firms will produce at each price, we simply
add up the amounts that each of the firms will
produce at that price.
Graphing Profit
A little trick for graphing a firm’s profit
Recall for a rectangle: Area = length . width
length
Area
width
We also know TR = P . Q.
So, if we can find a rectangle
whose length is P and whose
width is Q, then its area must
be total revenue.
P
TR
Q
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
ATC
Now, if we can find a rectangle
whose length is ATC and whose
width is Q, then its area is TC.
TC
Q
Then to determine profit,
we just subtract the TC area from the TR area.
Graphing Profit:
The six steps
Step 1 a. Draw your axes and label them Q and $.
( Label the origin 0.)
$
0
Quantity
Step 1b. Draw the firm’s ATC curve. (If the price is below the
minimum of ATC, you will also need to draw the AVC curve.)
$
MC
ATC
P
0
Quantity
Step 1 c. Draw the MC curve and D=MR curve. (For a
positive profit, D must be at least partly above ATC.)
$
MC
ATC
P
D = MR
0
Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC
$
P
0
ATC
D = MR
Q*
Quantity
Step 3: Find your TR = PQ rectangle.
MC
$
P
0
ATC
D = MR
Q*
Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
MC
$
P
ATC
D = MR
ATC
0
Q*
Quantity
Step 5: Find your TC = ATC . Q rectangle.
MC
$
P
ATC
D = MR
Q*
Quantity
Step 6: Find profit p = TR - TC.
MC
$
P
ATC
D = MR
profit
Q*
Quantity
You follow the same steps to
draw a firm that is making a loss
or breaking even (zero profits).
Let’s do a firm with a loss.
Step 1: Draw & label the curves & axes. For a loss, put D
above the minimum of AVC & below the minimum of ATC.
$
MC
ATC
AVC
P
D = MR
0
Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC
$
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 3: Find your TR = PQ rectangle.
$
MC
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 4: Determine ATC at the profit-maximizing
(or loss-minimizing) output level.
$
MC
ATC
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 5: Find your TC = ATC . Q rectangle.
$
MC
ATC
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 6: Find profit (or loss) p = TR - TC.
MC
$
ATC
AVC
loss
P
D = MR
0
Q*
Quantity
A firm that is breaking even
(zero profits)
Step 1: Draw & label the curves & axes. To break even,
make D tangent to the minimum of ATC.
$
P
0
MC
ATC
D = MR
Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC
$
D = MR
P
0
ATC
Q*
Quantity
Step 3: Find your TR = PQ rectangle.
MC
$
D = MR
P
0
ATC
Q*
Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
MC
$
D = MR
ATC = P
0
ATC
Q*
Quantity
Step 5: Find your TC = ATC . Q rectangle.
MC
$
D = MR
ATC = P
0
ATC
Q*
Quantity
Step 6: Find profit p = TR - TC.
MC
$
D = MR
ATC = P
0
ATC
Q*
Quantity
Adapting to Changes
in Demand
Constant Cost Industry
an industry in which costs of production remain
constant as output in the industry expands
Let’s start with the industry in long run equilibrium.
What is each firm’s economic profit (+, – , or 0)?
Zero.
That means that the price is at the minimum of the
ATC curve and is just sufficient to cover the cost
per unit of producing the good.
Next suppose that demand increases.
What happens to the price?
It increases.
If firms were just breaking even (zero economic profit) at
the old price, what will profit be at the new higher price?
It will be positive.
Does positive economic profit mean that the firms are
doing better, worse, or about the same as firms in other
industries are doing?
Better.
What is the nature of barriers to entry in perfect
competition?
There are no barriers to entry.
So we’ve got positive economic profit and no barriers to
entry. What will happen?
Firms will enter the industry.
What will happen to the supply of the product as new firms
enter the industry?
It will increase.
What happens to the price of the product?
It falls.
So the price goes back to where it was before the demand
change, but there is more output being produced by more
firms.
Note that if the price didn’t drop enough, there would still be
positive economic profits and firms would continue to enter
the industry, supply would keep increasing, and the price
would drop some more.
If the price dropped too much, it would not cover costs per
unit, and there would be losses. Firms would leave the
industry, supply would fall and the price would come back up
to just covering costs per unit.
So what has happened as a result of the increase
in demand in this constant cost industry?
We now have the same price we had before, but
we now have more output because we have more
firms in the industry.
So in a constant cost industry, firms will produce
as much or as little as the economy demands at a
price which is just enough to cover the cost per
unit.
That means that the long run supply curve in a
constant cost industry is horizontal.
Market
P
long run
supply curve
P1= P2
Q1
Q2
Increasing Cost Industry
an industry in which costs of production increase
as output in the industry expands
Let’s start again with the industry
in long run equilibrium.
What is each firm’s economic profit (+, – , or 0)?
Zero.
So the price is at the minimum of the ATC curve and is
just sufficient to cover the cost per unit of producing the
good.
Next suppose that demand increases.
What happens to the price?
It increases.
If firms were just breaking even (zero economic profit) at the
old price, what will happen to profit at the new higher price?
It will be positive.
Are the firms are doing better, worse, or about the same as
firms in other industries are doing?
Better.
What is the nature of the barriers to entry in perfect
competition?
There are no barriers to entry.
So we’ve got positive economic profit and no barriers to entry.
What will happen?
Firms will enter the industry.
What will happen to the supply of the product as
new firms enter the industry?
It will increase.
Before when we had a constant cost industry, the costs
remained the same as the industry expanded.
However, now we have an increasing cost industry. That
means that as the industry expands, it puts upward
pressure on the price of the inputs used in the industry
and the cost of production increases.
So visualize all the cost curves, including the ATC,
creeping up.
So the industry supply curve is shifting to the right,
and the ATC and other cost curves are creeping up.
As the supply increases, what happens to the price of the
product?
It falls.
But the price does not fall back to where it was before the
demand change, which was at the minimum of the old
ATC curve.
It only drops until we are back to zero economic profits
under the new conditions, which is at the bottom of the
new, higher, ATC curve.
So what has happened as a result of the increase
in demand in this increasing cost industry?
Supply expanded in response to the increased
profits resulting from the increase in demand.
However, costs increased so that we ended up
with a higher price that is just enough to cover
the new higher cost per unit.
That means that the long run supply curve in
an increasing cost industry is upward sloping.
Market
P
long run
supply curve
P2
P1
Q1
Q2 Q
Decreasing Cost Industry
an industry in which costs of production fall
as output in the industry expands
Let’s start again with the industry
in long run equilibrium.
What is each firm’s economic profit (+, – , or 0)?
Zero.
So the price is at the minimum of the ATC curve and is
just sufficient to cover the cost per unit of producing the
good.
Next suppose that demand increases.
What happens to the price?
It increases.
If firms were just breaking even at the old price, what
will happen to profit at the new higher price?
It will be positive.
Are the firms are doing better, worse, or about the same
as firms in other industries are doing?
Better.
What is the nature of the barriers to entry in perfect
competition?
There are no barriers to entry.
So we’ve got positive economic profit and no barriers to
entry. What will happen?
Firms will enter the industry.
What will happen to the supply of the product as
new firms enter the industry?
It will increase.
Now we have a decreasing cost industry. That means
that as the industry expands and infrastructure
improves, the cost of production decreases.
So visualize all the cost curves, including the ATC,
sliding down.
So the industry supply curve is shifting to the right,
and the ATC and other cost curves are sliding down.
As the supply increases, what happens to the price of the
product?
It falls.
But the price does not fall back to where it was before the
demand change, which was at the minimum of the old
ATC curve.
It keeps dropping until we are back to zero economic
profits under the new conditions, which is at the bottom
of the new, lower, ATC curve.
So what has happened as a result of the increase
in demand in this decreasing cost industry?
Supply expanded in response to the increased
profits resulting from the increase in demand.
However, costs decreased so that we ended
up with a lower price that is just enough to
cover the new lower cost per unit.
That means that the long run supply curve in an
decreasing cost industry is downward sloping.
Market
P
P1
P2
long run
supply curve
Q1
Q2
Q
Good Things about Perfect Competition
• Costs are minimized.
Competition forces efficient operation. Inefficient firms
will have losses and be forced out of business.
• P = MC
The price (which comes from the demand curve) is the
amount that consumers value a good.
MC is the cost of producing an additional unit of a good.
So firms produce up to the point where the amount that
consumers value a good is equal to the amount it costs to
produce an additional unit of the good.