Perfect competition

What is
market structure?
Important features of a market, such as the number of firms, product uniformity, ease of entry, and forms of competition

What are the four types of Markets?
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly

What is a
perfectly competitive market?
homogeneous product
many buyers and sellers
no one has much market power
easy entry & easy exit
can sell all bring to market

What is a price taker?
A firm that faces a given market price and whose actions have no effect on that market price

Why is a firm that is part of a perfectly competitive market a price taker?
Because if the firm charges higher than the market price it will not sell even one unit

Price per unit
Quantity per period
Market Equilibrium in Perfect Competition
D
S
0
Exhibit 1a
Surplus
Shortage

The Firm’s Demand Curve in Perfect Competition
Market quantity
P
S
D
Individual quantity
P
d

How does the firm maximize profit?
By finding the rate of output that makes total revenue minus total cost as large as possible

7
Maximum economic profit = $12
12
TR
TC
$60
48
15
Total dollars
Quantity per period
Short-Run Profit Maximization
Panel A: TR minus TC
15
10
5
0
Exhibit 3a

What is
marginal revenue?
The change in total revenue resulting from a one-unit change in sales

What is
marginal cost?
The change in total cost resulting from a one-unit change in sales

At what point are profits maximized?
At the level of output where MR = MC, or the last unit of output where MR > MC

Q MR TR TC MC ATC Profit
10 5 50 40.00 2.75 4.00 10.00 11 5 55 43.25 3.25 3.93 11.75
12 5 60 48.00 4.75 4.00 12.00
13 5 65 54.50 6.50 4.19 10.50
14 5 70 64.00 9.50 4.57 6.00
Exhibit 2
Maximizing Profits in the Short-Run

Why does MR = P in Perfect Competition?
Because no matter how many units are brought to market, the firm can sell all of them at the market price

What is
average revenue?
Total revenue divided by output
TR / Q

Why does AR=P
in all markets?
Because each unit is sold for the same price at one point in time

Total dollars
Quantity per period
Short-Run Profit Maximization
Panel B: MR equals MC
12
0
$5
$4
Profit
d = MR = AR
ATC
MC
e
a
Exhibit 3b

At what point are losses minimized?
At the level of output where MR = MC, or the last unit of output where MR > MC

Q MR TR TC MC ATC Loss
8 3 24 35.25 1.50 4.41 -11.25 9 3 27 37.25 2.00 4.14 -10.25
10 3 30 40.00 2.75 4.00 -10.00
11 3 33 43.25 3.25 3.93 -10.25
12 3 36 48.00 4.75 4.00 -12.00
Exhibit 4
Minimizing Losses in the Short-Run

What will a firm do if average variable cost exceeds price at every level of production?
Shut down

$40
30
15
Total dollars
Quantity per period
Minimizing Short-Run Losses
15
10
5
0
Minimum economic loss = $10
TR
TC
Panel A: TC and TR
Exhibit 5a

$4.00
3.00
2.50
15
10
5
0
Dollars per unit
Quantity per period
Minimizing Short-Run Losses
MC
AVC
ATC
d = MR = AR
Panel B: MC equals MR
Exhibit 5b
Loss

What is the firm’s short-run supply curve?
A curve that indicates the quantity a firm supplies at each price in the short run

Dollars per unit
Quantity per period
Summary of Short-Run Output Decisions
MC
ATC
AVC
Shutdown point
Break-even point
d1
d2
d3
d4
d5
Exhibit 5

What is the firm’s short run supply curve?
That portion of its MC curve which lies above its AVC curve

Total dollars
Quantity per period
Relationship between Short-Run Profit Maximization and Market Equilibrium
Panel A: Firm
12
10
5
0
$5
4
Profit
d=MR
ATC
MC = s
Exhibit 8a
AVC

What is the industry’s short-run supply curve?
A curve that indicates the quantity all firms in an industry supply at each price in the short run

Aggregating Individual Supply to Form Market Supply
Panel A: Firm A
Price per unit
Quantity per period
p'
p
10
20
0
SA
Exhibit 7a

Aggregating Individual Supply to Form Market Supply
Panel B: Firm B
Price per unit
Quantity per period
p'
p
10
20
0
SB
Exhibit 7b

Aggregating Individual Supply to Form Market Supply
Panel C: Firm C
Price per unit
Quantity per period
p'
p
10
20
0
SC
Exhibit 7c

Aggregating Individual Supply to Form Market Supply
Panel D: Industry, or market supply
Price per unit
Quantity per period
p'
p
30
60
SA + SB + SC = S
0
Exhibit 7d

Price per unit
Quantity per period
Relationship between Short-Run Profit Maximization and Market Equilibrium
Panel B: Industry, or market
12,000
0
$5
D
ΣMC = S
Exhibit 8b

What is economic profit in the long run?
Zero

Dollars per unit
Quantity per period
Long-Run Equilibrium for the Firm
q
0
p
d
ATC
MC
LRAC
e
Exhibit 9a

Price per unit
Quantity per period
Long-Run Equilibrium for the Industry
Q
0
p
D
S
Exhibit 9b

What is the long-run industry supply curve?
A curve that shows the relationship between price and quantity supplied once firms fully adjust to any change in market demand

What is an
increasing-cost industry?
An industry that faces higher per-unit production costs as industry output expands in the long run

Upward sloping
What is the shape of the long-run industry supply curve in an increasing cost industry?

What is
production efficiency?
The condition that exists when output is produced with the least-cost combination of inputs, given the state of technology

What is
allocative efficiency?
The condition that exists when firms produce the output that is most preferred by consumers

What is the the marginal cost of each good equal to?
The marginal benefit consumers derive from that good

What is
consumer surplus?
The difference between the maximum amount that a consumer is willing to pay for a given quantity of a good and what the consumer actually pays

What is
producer surplus?
The amount by which total revenue from production exceeds total variable cost

Consumer Surplus and Producer Surplus for a Competitive Market in the Short Run
Dollars per unit
Quantity per period
5
$10
0
10,000
20,000
12,000
6
e
m
S
D
Consumer surplus
Producer surplus
Exhibit 14

END

Appendix

What is a
constant-cost industry?
An industry that can expand or contract without affecting the long-run per-unit cost of production

What is the shape of the long-run industry supply curve?
horizontal

Dollars per unit
Quantity per period
q
0
p
d
ATC
MC
LRAC
d'
Profit
q'
p'
Panel A: the Firm
Exhibit 10a
Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry

Dollars per unit
Quantity per period
Long-Run Adjustment to a Decrease in Demand in a Constant Cost Industry for the Firm
q
0
p
d
ATC
MC
LRAC
e
p''
q''
d''
Loss
Exhibit 11a

Dollars per unit
Quantity per period
Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry
Qb
0
p
Qc
p'
Qa
S*
S'
S
D'
D
a
b
c
Exhibit 10b

Dollars per unit
Quantity per period
Qf
0
p''
Qa
p
Qg
S*
S
S''
D
D''
g
a
f
Exhibit 11b
Long-Run Adjustment to a Decrease in Demand in a Constant Cost Industry

Price per unit
Quantity per period
Qb
0
pa
pc
pb
Qc
Qa
S*
S'
S
D
D'
a
b
c
Exhibit 12b
Long-Run Adjustment to a Increase in Demand in an Increasing Cost Industry

Dollars per unit
Quantity per period
qb
0
pa
da
ATC
MC'
a
pc
q
dc
c
pb
MC
ATC'
db
b
Exhibit 12a
Long-Run Adjustment for the firm to an Increase in Demand in an Increasing Cost Industry

What is a
decreasing-cost industry?
The rare case in which an industry faces lower per-unit production costs as industry output expands in the long run

Downward sloping
What is the shape of the long-run industry supply curve in a decreasing cost industry?