Ch07-Monopoly

8/13/2019 Ch07-Monopoly

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7

CHAPTER Perfect

Competition


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Pearson Education 2012

After studying this chapter you will be able to:

Define perfect competition

Explain how firms make their supply decisions and why

they sometimes shut down temporarily

Explain how price and output are determined in aperfectly competitive market

Explain why firms enter and leave a competitive market

and the consequences of entry and exit

Predict the effects of a change in demand and of a

technological advance

Explain why perfect competition is efficient


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You might be relaxing over a cup of coffee, but coffee

shops operate in a fiercely competitive market with leanpickings for most of its producers.

How does competition in coffee and other markets

influence prices and profits?

We study a fiercely competitive market in this chapter.

We explain the changes in price and output as the firms in

perfect competition respond to changes in demand and

technological advances.


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What Is Perfect Competition?

Perfect competition is a market in which

1 Many firms sell identical products to many buyers.

2 There are no restrictions to entry into the market.

3 Established firms have no advantages over new ones.

4 Sellers and buyers are well informed about prices.



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How Perfect Competition Arises

Perfect competition arises when:

the firms minimum efficient scale is small relative to

market demand, so there is room for many firms in themarket.

each firm is perceived to produce a good or service

that has no unique characteristics, so consumers dont

care which firms good they buy.




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Price Takers

In perfect competition, each firm is a price taker.

A price takeris a firm that cannot influence the price of a

good or service.

No single firm can influence the price it must take the

equilibrium market price.

Each firms output is aperfect substitutefor the output ofthe other firms, so the demand for each firms output is

perfectly elastic.



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Figure 7.1 illustrates a firms revenue concepts.

Part (a) shows that market demand and market supply

determine the market price that the firm must take.


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Figure 7.1(b) shows the firms total revenue curve (TR) the relationship between total revenue and quantity sold.

If 9 jumpers are sold at a price of 25 each, total revenue

is 225.


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Figure 7.1(c) shows the marginal revenue curve (MR).The firm can sell any quantity it chooses at the market price,

so marginal revenue equals price and the demand curve for

the firms product is horizontal at the market price.


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The demand for Fashion First jumpers isperfectly elasticbecause they are a perfect substitute for other jumpers.

The market demand for jumpers is not perfectly elastic

because a jumper is a substitute for some other good.



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Profit-maximizing Output

A perfectly competitive firm chooses the output that

maximizes its economic profit.

One way to find the profit-maximizing output is to look atthe firms total revenue and total cost curves.

Figure 7.2 on the next slide looks at these curves along

with the firms total profit curve.


The Firms Output

Decision


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Part (a) shows the total

revenue, TR, curve.

Part (a) also shows thetotal cost curve, TC, which

is like the one in Chapter

10.

Total revenue minus totalcost is economic profit (or

loss), shown by the EP

curve in part (b).

The Firms Output

Decision


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At low output levels, the firm

incurs an economic loss it

cant cover its fixed costs.

At intermediate output

levels, the firm makes an

economic profit.

The Firms Output

Decision


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At high output levels, thefirm again incurs aneconomic loss now the

firm faces steeply risingcosts because ofdiminishing returns.

The firm maximizes its

economic profit when it

produces 9 jumpers a

day.

The Firms Output

Decision


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Marginal Analysis and the Supply Decision

The firm can use marginal analysis to determine the profit-

maximizing output.

Because marginal revenue is constant and marginal cost

eventually increases as output increases, profit is

maximized by producing the output at which marginal

revenue, MR, equals marginal cost, MC.

Figure 7.3 on the next slide shows the marginal analysis

that determines the profit-maximizing output.


The Firms Output

Decision


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If MR> MC, economic

profit increases if output

increases.

If MR< MC, economic

profit increases if output

decreases.

If MR= MC, economicprofit decreases if output

changes in either

direction, so economic

profit is maximized.

The Firms Output

Decision


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Temporary Shutdown Decision

If the firm makes an economic loss, it must decide to exit

the market or to stay in the market.

If the firm decides to stay in the market, it must decidewhether to produce something or to shut down

temporarily.

The decision will be the one that minimizes the firms loss.

The Firms Output

Decision


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Loss Comparisons

The firms loss equals total fixed cost (TFC) plus totalvariable cost (TVC) minus total revenue (TR).

Economic loss = TFC + TVCTR

= TFC + (AVC P) x Q

If the firm shuts down, Qis 0 and the firm still has to payits TFC.

So the firm incurs an economic loss equal toTFC.

This economic loss is the largest that the firm must bear.

The Firms Output

Decision


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The Shutdown Point

A firms shutdown pointis the price and quantity at which

it is indifferent between producing and shutting down.

This point is whereAVCis at its minimum.

It is also the point at which the MCcurve crosses theAVC

curve.

At the shutdown point, the firm is indifferent betweenproducing and shutting down temporarily.

The firm incurs a loss equal to TFCfrom either action.

The Firms Output

Decision


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Figure 7.4 shows the

shutdown point.

MinimumAVCis 17 a

jumper.

If the price is 17, the

profit-maximizing output is

7 jumpers a day.

The firm incurs a lossequal to the red rectangle.

The Firms Output

Decision


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If the price of a sweater is

between 17 and 20.14:

the firm produces the

quantity at which

marginal cost equals

price.

The firm covers all its

variable cost and some

of its fixed cost.

It incurs a loss that is

less than TFC.

The Firms Output

Decision


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If price is less than the minimum average variable cost, the

firm shuts down temporarily and incurs an economic loss

equal to total fixed cost.

This economic loss is the largest that the firm must bear.

If the firm were to produce just 1 unit of output at a price

below minimum average variable cost, it would incur an

additional (and avoidable) loss.


The Firms Output

Decision


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The Firms Supply Curve

Figure 7.5 shows how the

firms short-run supply curve

is constructed.If price equals minimum

average variable cost, 17,

the firm is indifferent between

producing nothing andproducing at the shutdown

point, T.

The Firms Output

Decision


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If the price is 25, the firm


day, the quantity at which

P= MC.

The blue curve in part (b)

traces the firms short-run

supply curve.

If the price is 31, the firm


day, the quantity at which

P= MC.

The Firms Output

Decision


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Market Supply in the Short Run

The short-run market supply curveshows the quantity

supplied by all the firms in the market at each price when

each firms plant and the number of firms remain constant.

Output, Price and Profit in the Short Run


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Figure 7.6 shows thesupply curve for a market

that has 1,000 firms like

Fashion First.

The quantity supplied by

the market at any given

price is the sum of the

quantities supplied by all

the firms in the market atthat price.



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At a price equal to

minimum average variable

costthe shutdown price

the market supply curveis perfectly elastic

because some firms will

produce the shutdown

quantity and others willproduce zero.



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Short-run Equilibrium

Short-run market supply

and market demand

determine the market

price and output.

Figure 7.7 shows a short-

run equilibrium.



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A Change in Demand

An increase in demand

bring a rightward shift of

the market demand curve:the price rises and the

quantity increases.

A decrease in demand

bring a leftward shift of themarket demand curve: the

price falls and the quantity

decreases.



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The Firms Output Decision

Three Possible Short-run Outcomes

Maximum profit is not always a positive economic profit.

To determine whether a firm is making an economic profitor incurring an economic loss, we compare the firms

average total cost at the profit-maximizing output with the

market price.

Figure 7.8 on the next slide shows the three possible profitoutcomes.



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In part (a) price equalsaverage total costof producing theprofit-maximizing quantity and the firm makes zeroeconomic profit (breaks even).



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In part (b), price exceedsaverage total cost of producingthe profit-maximizing quantity and the firm makes apositive economic profit.



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In part (c) price is less thanaverage total cost ofproducing the profit-maximizing quantity and the firm

incurs an economic loss economic profit is negative.



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Long-run Adjustments

In short-run equilibrium, a firm may make an economic

profit, break even, or incur an economic loss.

Which of these outcomes occurs determines how themarket adjusts in the long run.

In the long run, firms can enter or exit the market.

Output, Price and Profit in the Long Run


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Entry and Exit

New firms enter a market in which existing firms make an

economic profit.

Firms exit a market in which they incur an economic loss.

Figure 7.9 on the next slide shows the effects of entry and

exit.



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A Closer Look at EntryNew firms enter a market in which existing firms make an

economic profit.



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As new firms enter amarket, the market

supply increases.

The market supply

curve shifts rightward.

The price falls, the

quantity increases

and the economicprofit of each firm

decreases.



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A Closer Look at ExitNew firms exit a market in which existing firms incur

economic loss.



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As firms exit a

market, the market

supply decreases.

The market supplycurve shifts leftward.

The price rises, the

quantity decreases

and the economicloss of each firm

remaining in the

market decreases.



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Long-run EquilibriumLong-run equilibrium occurs in a competitive market

when economic profit and economic loss have been

eliminated and entry and exit have stopped.



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Changing Tastes and Advancing

Technology

A Permanent Change in Demand

A decrease in demand shifts the market demand curve

leftward. The price falls and the quantity decreases.

Figure 7.10 illustrates the effects of a permanent decreasein demand when the market is in long-run equilibrium.



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Technology

A decrease in demand shifts the market demand curve

leftward. The market price falls and each firm decreases

the quantity it produces.



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Technology

The market price is now below each firms minimum

average total cost, so firms incur economic losses.



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Technology

Economic losses induce some firms to exit, which

decreases the market supply and the price starts to rise.



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Technology

As the price rises, the quantity produced by the market

continues to decrease as more firms exit, but each firm

remaining in the market starts to increase its quantity.



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Technology

A new long-run equilibrium occurs when the price has risen toequal minimum average total cost. Firms do not incur

economic losses and firms no longer exit the market.



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Technology

The main difference between the initial and new long-runequilibrium is the number of firms in the market.

Fewer firms produce the equilibrium quantity.



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TechnologyA permanent increase in demand has the opposite effects

to those just described and shown in Figure 7.10.

An increase in demand shifts the demand curve rightward.

The price rises and the quantity increases.

Economic profit induces entry, which increases short-run

supply and shifts the short-run market supply curve

rightward.

As market supply increases, the price falls and the marketquantity continues to increase.



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Technology

With a falling price, each firm decreases production in a

movement along the firms marginal cost curve (short-run

supply curve).

A new long-run equilibrium occurs when the price hasfallen to equal minimum average total cost.

Firms do not make economic profits, and firms no longer

enter the market.

The main difference between the initial and new long-run

equilibrium is the number of firms. In the new equilibrium,

a larger number of firms produce the equilibrium quantity.



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Technology

External Economics and Diseconomies

The change in the long-run equilibrium price following a

permanent change in demand depends on external

economies and external diseconomies.

External economiesare factors beyond the control of an

individual firm that lower the firms costs as the market

output increases.

External diseconomiesare factors beyond the control of

a firm that raise the firms costs as the marketoutput

increases.



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Technology

In the absence of external economies or external

diseconomies, a firms costs remain constant as market

output changes.

Figure 7.11 illustrates the three possible cases and showsthe long-run market supply curve.

The long-run market supply curveshows how the

quantity supplied by the market varies as the market price

varies after all the possible adjustments have been made,including changes in each firms plant and the number of

firms in the market.



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Technology

An increase in demand raises

the price in the short run.

Figure 7.11(a) shows that in

the absence of externaleconomies or external

diseconomies, an increase in

demand does not change the

price in the long run.

The long-run market supply

curve LSAis horizontal.

C


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Technology

Figure 7.11(b) shows that

when external diseconomies

are present, an increase in

demand brings a higher price

in the long run.

The long-run market supply

curve LSBis upward sloping.

Ch i T t d Ad i


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Technology

Figure 7.11(c) shows that

when external economies

are present, an increase in

demand brings a lower

price in the long run.

The long-run market

supply curve LSCis

downward sloping.


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Technology

Technological Change

New technologies are constantly discovered that lower

costs.A new technology enables firms to produce at a lower

average total cost and a lower marginal cost firms cost

curves shift downward.

Firms that adopt the new technology make an economicprofit.



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Technology

New-technology firms enter and old-technology firms

either exit or adopt the new technology.

The market supply increases and the market supply curveshifts rightward.

The price falls and the quantity increases.

Eventually, a new long-run equilibrium emerges in which

all firms use the new technology, the price equalsminimum average total cost and each firm makes zero

economic profit.



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Competition and Efficiency

Efficient Use of Resources

Resources are used efficiently when no one can be made

better off without making someone else worse off.

This situation arises when marginal social benefit equalsmarginal social cost.



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Choices, Equilibrium and Efficiency

We can describe an efficient use of resources in terms ofthe choices of consumers and firms coordinated in marketequilibrium.

Choices

A consumers demand curve shows how the best budgetallocation changes as the price of a good changes.

So consumers get the most value out of their resources atall points along their demand curves.

With no external benefits, the market demand curve is themarginal social benefit curve.



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A competitive firms supply curve shows how the profit-

maximizing quantity changes as the price of a good

changes.

So firms get the most value out of their resources at all

points along their supply curves.

With no external cost, the market supply curve is the

marginal social cost curve.



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Equilibrium and Efficiency

In competitive equilibrium, resources are used efficiently

the quantity demanded equals the quantity supplied, so

marginal social benefit equals marginal social cost.

The gains from trade for consumers is measured by

consumer surplus.

The gains from trade for producers is measured by

producer surplus.

Total gains from trade equal total surplus, and in long-run

equilibrium total surplus is maximized.



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Figure 7.12 illustrates anefficient allocation ofresources in a perfectly

competitive market.In part (a), each firm isproducing at the lowestpossible long-runaverage total cost on

LRACat the price P*and the quantity q*.


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Figure 7.12(b) shows themarket.

Along the market demand

curve D= MSB,

consumers are efficient.

Along the market supply

curve S= MSC,

producers are efficient.


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The quantity Q* and priceP* are the competitive

equilibrium values.

So competitive equilibrium

is efficient.

Total surplus, the sum of

consumer surplus and

producer surplus ismaximized.

Ch07-Monopoly

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