CHAPTER 7 PERFECT COMPETITION - Dr. Nghia's Blog · CHAPTER 7 PERFECT COMPETITION 1 ... Chapter 7 2...
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CHAPTER 7 PERFECT COMPETITION 1 Part Two: Microeconomics of Product Markets Slides prepared by Bruno Fullone, George Brown College ©2010 McGraw-Hill Ryerson Ltd.
Transcript of CHAPTER 7 PERFECT COMPETITION - Dr. Nghia's Blog · CHAPTER 7 PERFECT COMPETITION 1 ... Chapter 7 2...
CHAPTER 7
PERFECT COMPETITION
1
Part Two: Microeconomics of Product Markets
Slides prepared by Bruno Fullone,
George Brown College ©2010 McGraw-Hill Ryerson Ltd.
Chapter 7
2
In this chapter you will learn:
7.1 The four basic market structures
7.2 The conditions required for perfectly
competitive markets
7.3 How firms in perfect competition maximize
profits or minimize losses
7.4 Why the marginal cost curve and supply curve
of competitive firms are the same
7.5 About the firm’s profit maximization in the long
run
7.6 About the efficiency of competitive markets
7.1 Four Market Structures
• Perfect competition
• Monopoly
• Monopolistic competition
• Oligopoly
Market Structure Continuum
Perfect Competition
Monopolistic Competition Oligopoly
Monopoly
Imperfect Competition
3 LO 7.1
LO 7.2 4
Market Structure Continuum
Pure
Competition
Pure
Monopoly Monopolistic
Competition Oligopoly
7.2 Characteristics of Perfect
Competition • Very Large Numbers
• Standardized Product
• Price-Takers
• Easy Entry and Exit
5 LO 7.2
Demand for a Firm in Perfect
Competition
•Perfectly Elastic Demand
•Average, Total, and Marginal
Revenue
•average revenue = price
•marginal revenue = price
•total revenue = price x quantity
•Illustrated…
7.2
6
Product price, P
(average revenue)
Quantity demanded
, Q
Total Revenue,
TR
Marginal Revenue,
MR
131 0 0
131 1 131
131 2 262
131 3 393
131 4 524
131 5 655
131 6 786
131 7 917
131 8 1048
131 9 1179
131 10 1310
Product price, P
(average revenue)
Quantity demanded
, Q
Total Revenue,
TR
Marginal Revenue,
MR
131 0
131 1
131 2
131 3
131 4
131 5
131 6
131 7
131 8
131 9
131 10
] 131
] 131
] 131
] 131
] 131
] 131
] 131
] 131
] 131
] 131
LO 7.2
7
Figure 7-1 The Demand and Revenue Curves
for a Firm in Perfect Competition
D = MR = AR
TR
1179
1048
917
786
655
524
393
262
131
0
Quantity Demanded
2 4 6 8 10 12
Price a
nd r
evenue
Demand is perfectly
elastic since the firm
can sell as much
output as it wants at
the market price
8 LO 7.3
7.3 Profit Maximization in the Short Run
• Perfectly competitive firm can
maximize its profit (minimize
its loss) only by adjusting
output
• Two Approaches:
• total revenue-total cost
approach
• marginal revenue-marginal
cost approach
LO 7.3 9
Q TFC TVC TC TR Profit or
Loss
0
1
2
3
4
5
6
7
8
9
10
Q TFC TVC TC TR Profit
or Loss
0 $100
1 100
2 100
3 100
4 100
5 100
6 100
7 100
8 100
9 100
10 100
Q TFC TVC TC TR Profit
or Loss
0 $100 $ 0
1 100 90
2 100 170
3 100 240
4 100 300
5 100 370
6 100 450
7 100 540
8 100 650
9 100 780
10 100 930
Q TFC TVC TC TR
Profit
or
Loss
0 $100 $ 0 $
100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030
Q TFC TVC TC TR
Profit
or
Loss
0 $100 $ 0 $
100
$ 0
1 100 90 190 131
2 100 170 270 262
3 100 240 340 393
4 100 300 400 524
5 100 370 470 655
6 100 450 550 786
7 100 540 640 917
8 100 650 750 1048
9 100 780 880 1179
10 100 930 1030 1310
Q TFC TVC TC TR
Profi
t or
Loss
0 $10
0
$
0
$
100
$
0
$-
100
1 100 90 190 131 -
59
2 100 170 270 262 -
8
3 100 240 340 393 +
53
4 100 300 400 524 +12
4
5 100 370 470 655 +18
5
6 100 450 550 786 +23
6
7 100 540 640 917 +27
7
8 100 650 750 104
8
+29
8
9 100 780 880 117
9
+29
9
10 100 930 103
0
131
0
+28
0
p=$131
LO 7.3
10
Profit Maximization, Perfect Competition
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
0 2 4 6 8 10 12 14
Quantity
$
TC TR TR Maximum
economic profit
$299
Break-even point (normal
profit)
Break-even point
Figure 7-2
11 LO 7.3
Total Revenue-Total Cost Approach
•Profit = TR - TC
•Profit is maximized where the
vertical distance between TR and
TC is maximized
•Break-even points are where
TR=TC
•Now, the marginal revenue-
marginal cost approach…
LO 7.3 12
Q TFC TVC TC
0 $100 $ 0 $ 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030
MC
$
90
80
70
60
70
80
90
110
130
150
]
]
]
]
]
]
]
]
]
Figure 7-3
MC MR
$
90
$1
31
80 13
1
70 13
1
60 13
1
70 13
1
80 13
1
90 13
1
11
0
13
1
13
0
13
1
15
0
13
1
Should the
firm produce
the 1st unit? What about
the 2nd unit?
What about
the 9th unit?
9 units will maximize profits
the same profit-maximizing result
as with the TR-TC approach!
]
13 LO 7.3
Marginal Revenue-Marginal Cost Approach
Short run profit maximization occurs where
MR=MC:
1. Rule applies only if producing is
preferable to shutting down
2. Rule is an accurate guide to profit
maximization for ALL firms
3. Rule can be restated as P=MC for
perfectly competitive firms, since MR=P
LO 7.3
14
Figure 7 - 3
0
40
80
120
160
200
0 2 4 6 8 10
Output
Co
st &
Re
ve
nu
e
MC
ATC
AVC
AFC
9
131
Find the quantity
where MR=MC
97.78 Find ATC
Profit = 9 X (131 - 97.78) = 299
15 LO 7.3
Loss-Minimizing Case
•Suppose price falls from $131 to
$81…
LO 7.3 16
Q TFC TVC TC
0 $100 $ 0 $ 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030 Figure 7-4
MC MR
$9
0
80
$8
1
70 81
60 81
70 81
80 81
90 81
11
0
81
13
0
81
15
0
81
]
]
]
]
]
]
]
]
]
Firm should
produce the
first 6 units
]
LO 7.3 17
0
40
80
120
160
200
0 2 4 6 8 10
Co
st &
Re
ve
nu
e
Output
Figure 7 - 4
MC
ATC
AVC
AFC
81
91.67
Loss = 6 X (81 - 91.67) = -64.02 < TFC
LO 7.3 18
Shutdown Case
• Suppose the price falls even further, to
$71…
LO 7.3
19
Figure 7- 5
0
40
80
120
160
200
0 2 4 6 8 10
Output
Co
st &
Re
ve
nu
e
MC
ATC
AVC
AFC
71
94 Loss = 5 X (71 - 94) = -115>TFC
5
When price is below
minimum AVC, the firm
should shut down
LO 7.4 20
P
Q
MC ATC
Co
sts
an
d r
ev
en
ues (
do
llars
)
At every price, the
MR = MC point
indicates the quantity
being produced...
AVC
7.4 Marginal Cost and Short-Run Supply Figure 7.6
LO 7.4 21
P
Q
MC ATC
Record the
quantity being
supplied for
each price
Co
sts
an
d r
ev
en
ues
(d
oll
ars
)
P3 MR3
Q3
AVC
Marginal Cost and Short-Run Supply
LO 7.4 22
P
Q
MC ATC
MR2
MR3 P2
P3
Q2 Q3
At a lower price
a lower quantity
will be supplied
Co
sts
an
d r
ev
en
ues
(d
oll
ars
)
AVC
Marginal Cost and Short-Run Supply
LO 7.4 23
P
Q
MC ATC
MR2
MR3
MR4
P2
P3
P4
Q3 Q4
At a higher price
a higher quantity
will be supplied
Q2
Co
sts
an
d r
ev
en
ues
(d
oll
ars
)
AVC
Marginal Cost and Short-Run Supply
LO 7.4
24
Q
P
P1
MC
MR1
AVC
ATC
MR2
MR3
MR4
MR5
P2
P3
P4
P5
Q2 Q3 Q4 Q5
Firm should not
produce
below P2
Co
sts
an
d r
ev
en
ues
(d
oll
ars
)
Marginal Cost and Short-Run Supply
LO 7.4 25
Q
P
P1
MC
MR1
AVC
ATC
MR2
MR3
MR4
MR5
P2
P3
P4
P5
Q2 Q3 Q4 Q5
Co
sts
an
d r
ev
en
ues
(d
oll
ars
) Short-run
supply curve
(Above AVC)
Marginal Cost and Short-Run Supply
LO 7.4 26
Marginal Cost and Short-run Supply
• Firm’s short-run supply curve is the portion of
its MC curve above minimum AVC
• Diminishing Returns, Production Costs, and
Product Supply
• Supply curve shifts:
– A wage increase shifts the supply curve upward and
to the left (decreasing in supply)
– Technological progress would shift the supply curve
downward to the right (increasing in supply)
LO 7.4 27
MC
AVC
8
D
8000
D
$111 $111
1000 firms
Industry Firm
(price taker)
Q Q
P P S=MCs
Competitive Equilibrium for a Firm and the Industry Figure 7-7
ATC
Economic
Profit
LO 7.4 28
Table 7-4 Output Determination in Perfect
Competition in the Short Run
Questio
n
Answer
Should
this firm
produce
?
Yes, if P ≥
minimum ATC; this
means that the firm
is profitable or that
its losses are less
than its fixed cost
What
quantity
should
the firm
produce
?
Produce where MR
(=P) = MC; there,
profit is maximized
or loss is minimized
Will
productio
n result
in
economi
c profits?
Yes, if P > ATC
(TR > TC)
29 LO 7.5
7.5 Profit Maximization in the Long
Run
•Assumptions:
•Entry and Exit Only
•Identical Costs
•Constant-Cost Industry
30 LO 7.5
The Goal of Our Analysis
In the long run, p = minimum ATC
Because:
1. Firms seek profit and avoid
losses
2. Firms are free to enter and exit
the industry
LO 7.5 31
P
Q
MC P
Q
S1
Industry
1000 firms
Firm
(price taker)
ATC
MR $60
$50
$40
100
$60
$50
$40
100,000
D1
Figure 7-8 Entry Eliminates Economic Profits
D2
Economic Profits
LO 7.5 32
P
Q
MC P
Q
D1
S1 ATC
MR $60
$50
$40
100
$60
$50
$40 D2
100,000
S2
Industry
110,000 firms
Firm
(price taker)
Entry Eliminates Economic Profits
110,000
New Equilibrium with more firms
LO 7.5 33
P
Q
MC P
Q
D1
S1
ATC
MR $60
$50
$40
100
$60
$50
$40
100,000
Industry
1000 firms
Firm
(price taker)
Figure 7-9 Exit Eliminates Losses
D2
Economic Loss
LO 7.5 34
P
Q
MC P
Q
D1
S1
ATC
MR $60
$50
$40
100 90,000
D2
S3
100,000
$60
$50
$40
Industry
90,000 firms
Firm
(price taker)
Exit Eliminates Losses
New equilibrium with fewer firms
LO 7.5 35
Long-Run Equilibrium
• If price > min ATC
– profits attract new firms
– as S increases, price drops to min ATC
• If price < min ATC
– losses cause firms to exit
– as S decreases, price rises to min ATC
• So, in the long run, p = min ATC
LO 7.5 36
Illustrated…
Long-run Supply
• Crucial factor is whether the number of
firms in the industry affects the costs of
individual firms
LO 7.5
37
Q
P=$50
D1
Q1
S1
Q2
P
Figure 7-10 Long-run Supply for a Constant-
Cost Industry Is Horizontal
D2
Demand
increases P>$50
D2
Q2
Profits
attract new
firms
Price remains the same in the long run
LO 7.5 38
P
Q
P=$50
D1
Q1
Figure 7-11 Long-run Supply for an
Increasing-Cost Industry Is Upsloping S1 Demand
increases
D2
P>>$50
Q2
Profits
attract new
firms
In the long run, greater supply is offered at a
higher price
LO 7.5
39
P
Q
P=$50
D1
Q1
Long-run Supply for a Decreasing-Cost
Industry Is Downsloping S1 Demand
increases
D2
P>$50 Profits
attract new
firms
P<$50
Q2
long-run S
In the long run, greater supply is offered at a
lower price
LO 7.6 40
7.6 Perfect Competition and Efficiency
P
Q
P MR
Q
MC ATC
Price = MC = Minimum ATC
(normal profit)
Figure 7-12
LO 7.6 41
Perfect Competition and Efficiency
• Productive Efficiency
– P = Minimum ATC
• Allocative Efficiency
– P = MC
42
LO 7.6
Allocative Efficiency and
Consumer and Producer Surplus
•Consumer Surplus is the difference
between what the consumer is willing
to pay and the market price
•Producer Surplus is the difference
between the marginal cost of
production and the market price
•At equilibrium, consumer and
producer surplus is maximized
Chapter 7.6 43
Long-Run Equilibrium:
A Competitive Firm and Market P
Q
Pe
Qe
Consumer
Surplus
Producer
Surplus
The sum of
consumer and
producer surplus
is maximized
Figure 7-12
44
LO 7.6
Perfect Competition and Efficiency
•Productive Efficiency
•P = Minimum ATC
•Allocative Efficiency
•P = MC
•Dynamic Adjustments
•perfectly competitive markets adjust
to restore efficiency when disrupted
by changes in the economy
45
LO 7.6
The “Invisible Hand” Revisited
•The efficient allocation of
resources in perfect competition
comes about because businesses
and resource suppliers seek to
further their self-interest
•Both business profits and
consumer satisfaction are
maximized
46
Chapter 7
The Last Word: The Case of Generic Drugs
•Efficiency gains from entry
•Lower price and greater output
•Purpose of drug patent
•Encourage R&D
•Cost recovery
•Expiration of patent on drugs
•Generics enter
•Profits decrease, output increase
•Combined CS and PS increase
Pri
ce
Quantity
P1
P2
D
S
Q1 Q2
f
a
d
c b
• As price decreases to f,
• Consumer surplus abc
increases to adf • Producer and
consumer surplus is
maximized as shown by the gray triangle
Initial Patent Price
Result: Greater Quantity at Lower Prices
as Predicted by the Competitive Model
New Producers Enter Market
Chapter 7
The Case of Generic Drugs
Chapter 7 48
Chapter 7 Summary 7.1 Four Market Structures
7.2 Characteristics of Perfect Competition and the Firm’s Demand Curve
7.3 Profit Maximization in the Short Run MR ( = P) = MC ; TR – TC is the highest
7.4 Marginal Cost and Short-Run Supply Firm’s short-run MC that Lies above its AVC
7.5 Profit Maximization in the Long Run
7.6 Perfect Competition and Efficiency P = ATC = MC
