Economics 111.3 Winter 14

Economics 111.3 Winter 14March 21st, 2014Lecture 25Ch. 12: Perfect competition

12Perfect CompetitionThe concept of competition is used in two ways in economics.Competition as a process is a rivalry among firms.Competition as a market structure. 2OligopolyMarket Structure ContinuumPureCompetitionPureMonopolyMonopolisticCompetitionFour Market StructuresMarket structure involves the number of firms in the market and the barriers to entry.3Minimum Efficient ScaleMESLRATC4Under Pure Competition:The number of firms is large.Both buyers and sellers are price takers.The firms' products are identical (standardized or homogeneous).There is free entry and exit, that is, there are no barriers to entry.There is complete information.Firms are profit maximizers.Fully flexible exchange rates

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Since both buyers and sellers are price takers, demand - as it is seen by the individual producer - is perfectly elasticDSDQpindustryp1A perfectly competitive firms demand is horizontal (perfectly elastic), even though the demand curve for the industry is downward sloping.

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Market (industrys) case

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Profit Maximization in the Short RunPurely competitive firm can maximize its profit (minimize its loss) only by adjusting outputTwo Approaches:total revenue-total cost approachmarginal revenue-marginal cost approach13

Copyright 2013 Pearson Canada Inc., Toronto, OntarioTotal Revenue-Total Cost ApproachProfit = TR - TCProfit is maximized where the vertical distance between TR & TC is maximizedBreak-even points where TR=TCTCTRTR15QTFCTVCTCTRProfit or Loss0$100$ 0$ 100$ 01100901901312100170270262310024034039341003004005245100370470655610045055078671005406409178100650750104891007808801179101009301030131016QTFCTVCTCTRProfit or Loss0$100$ 0$ 100$ 0$-100110090190131- 592100170270262- 83100240340393+ 534100300400524+1245100370470655+1856100450550786+2367100540640917+27781006507501048+29891007808801179+2991010093010301310+28017

MR-MC ApproachShort run profit maximization occurs where MR=MCguide to profit maximization for ALL firmsrule can be restated as P=MC for purely competitive firms, since MR=P19If MR > MC, economic profit increases if output increases.If MR < MC, economic profit decreases if output increases.If MR = MC, economic profit decreases if output changes in either direction, so economic profit is maximized.

The Firms Output Decision: MR-MC Approach

2010 Pearson Education Canada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MCATCAVCAFC913131MCATCAVCAFC913197.7832MCATCAVCAFC9Profit = 9 X (131 - 97.78) = 29913197.7833Study questionHow would a rational, profit-maximizing competitive firm respond in the short-run to an increase in fixed costs? Will there be any change in equilibrium price or quantity in the short-run? Explain.

C:\Users\Rohan Ron\Post-Secondary\U of SASK\COURSES AT SASKATCHEWAN UNIVERSITY\Price Theory & Resource - MicroEconomics (ECON 111)\Lecture Notes Anna Klimina\ECON 111 Lecture Notes 25 Slide 34-35 Recording

In part (c) price is less than average total cost and the firm incurs an economic losseconomic profit is negative.

Output, Price, and Profit in the Short Run

2010 Pearson Education Canada41Operating a business at a loss. Students often have a hard time understanding why operating at an economic loss can be the best action. The key is appreciating that:The firms short-run decisions are made after some irrevocable commitments have generated sunk costs.The firm considers only avoidable costs when making decisions. Unavoidable costs have no impact on the decision.So for the firm to produce its revenues need only exceed avoidable costs, not total costs.The profit-maximization goal doesnt require the firm to make a positive economic profit in the short run.

P = 131QTFCTVCTC0$100$ 0$ 10011009019021001702703100240340410030040051003704706100450550710054064081006507509100780880101009301030MCMR$ 90$1318013170131601318013190131110131130131150131]]]]]]]]]43Loss-Minimizing CaseSuppose price falls from $131 to $8144QTFCTVCTC0$100$ 0$ 10011009019021001702703100240340410030040051003704706100450550710054064081006507509100780880101009301030MCMR$ 90$8180817081608180819081110811308115081]]]]]]]]]45

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