The objectives of this chapter are to introduce perfect competition. After studying this chapter you will be able to understand: The characteristics of perfect competition; the perfect competitor’s demand curve; the short run and and the long run; economic and accounting profits; decreasing, constant, and increasing cost industries.
Trang 1Perfect Competition
Trang 4• There are so many firms that no one firm
is large enough to influence price – Either by withholding output from the market or by increasing its output
• The firms are selling an identical product
– A product is identical, in the minds of the buyers, if they have no reason to prefer one seller over another
Trang 5• The market has perfect mobility
– No barriers to entry such as licenses, long
term contracts, government franchises, patents, control over vital resources, etc.
– One possible exception is money
• Perfect knowledge about the market exist
– Everyone knows about every possible economic opportunity
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price that is taken by the individual firm, in this case $6
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The perfect competitor faces a horizontal , or perfectly elastic, demand curve
A firm with a perfectly elastic demand curve has an identical MR curve (MR=P)
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The perfect competitor has to take the market price (it is a price taker!)
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Why is the individual firm’s demand curve flat instead of sloping down to the right?
The individual firm’s output is between 0 & 30 units. The industry’s output in the millions. It is impossible for the individual firm to increase output enough to change the price even one cent.
Theoretically, the individual firm’s demand curve slopes down and to the right ever so slightly. But we
30/4,000,000 = .0000075
75 10,000,000
Trang 1020 18 16 14 12 10 8 6 4 2 0
D,MR ATC MC
0 2 4 6 8 10 12 14 16 18 20
The Perfect Competitor in the Short Run
In the short run the perfect competitor may make a profit or lose money
Trang 1120 18 16 14 12 10 8 6 4 2 0
D,MR ATC MC
0 2 4 6 8 10 12 14 16 18 20
The Perfect Competitor in the Short Run
Is this firm making a profit or losing money?
Answer: Losing money because the D,MR curve is below the ATC curve
Trang 1220 18 16 14 12 10 8 6 4 2 0
D,MR ATC MC
Trang 13Output
20 18 16 14 12 10 8 6 4 2 0
D,MR ATC
MC
0 2 4 6 8 10 12 14 16 18 20
Is this firm making a profit or losing money?
Answer: Making a profit because the D,MR curve is above the ATC curve
Trang 14Output
20 18 16 14 12 10 8 6 4 2 0
D,MR ATC
Trang 15Output
D,MR ATC
MC Firm
D
S
Market 20
18 16 14 12 10 8 6 4 2 0
20 18 16 14 12 10 8 6 4 2 0
Output (in millions)
0 2 4 6 8 10 12 14 16 18 20
In the long run the perfect competitor breaks even
Since the ATC curve lives above the demand curve, the firm is losing money at a price of $6. How do we then get to the long run where the firm is breaking even?
Trang 16D2,MR2ATC
MC Firm
Output (in millions)
D
S2Market
Trang 17D2,MR2ATC
MC Firm
Output (in millions)
D
S2Market
Trang 18D2,MR2ATC
MC Firm
Output (in millions)
D
S2Market
Trang 19Breaking Even in the Long Run
Output
D2,MR2ATC
MC Firm
Output (in millions)
D
S2Market
D1,MR1
S1
20 18 16 14 12 10 8 6 4 2 0
20 18 16 14 12 10 8 6 4 2 0
0 2 4 6 8 10 12 14 16 18 20 0 1 2 3
At a price of $10 all firms in the industry are making a profit
Trang 20Breaking Even in the Long Run
Output
D2,MR2ATC
MC Firm
Output (in millions)
D
S2Market
D1,MR1
S1
20 18 16 14 12 10 8 6 4 2 0
20 18 16 14 12 10 8 6 4 2 0
0 2 4 6 8 10 12 14 16 18 20 0 1 2 3
New firms are attracted into the industry. This increases supply moving the
supply curve from S 1 to S 2
Trang 21Breaking Even in the Long Run
Output
D2,MR2ATC
MC Firm
Output (in millions)
D
S2Market
D1,MR1
S1
20 18 16 14 12 10 8 6 4 2 0
20 18 16 14 12 10 8 6 4 2 0
0 2 4 6 8 10 12 14 16 18 20 0 1 2 3
This reduces the industry price to $8, at which the firms break even
Trang 22Output
24 23 22 21 20 19 18 17 16 15
D,MR
ATC MC
Trang 23Output
24 23 22 21 20 19 18 17 16 15
D,MR
ATC MC
Trang 24• A firm operates at peak efficiency when it
produces at the lowest possible cost
– That would be the minimum point of its ATC curve ( the breakeven point)
• For the perfect competitor in the long run, the
most profitable output is at the minimum point
of is ATC curve because this will be where MC=MR
• Because of the degree of competition, the
perfect competitor is forced to operate at peak efficiency
– Other forms of competition do not force firms to operate at peak efficiency
Trang 25• Accounting profits are what is left over
from sales (revenue) after a firm has paid all of its explicit cost
Trang 26Suppose you have invested $100,000 of your own money in your business. You could have earned $15,000 interest on this money. Instead of you and your
spouse working 12 hours a day , seven days a week, you both could have earned
$70,000 working for some one else. ($15,000 + $70,000 = $85,000 implicit cost)
Trang 27• Why stay in business if your economic
profits are zero?
– You are still making accounting profits – You wouldn’t do any better if you invested your money elsewhere and worked for
someone else – You are your own boss by having your own business
Economic and Accounting Profits
Trang 28• When economic profits become negative,
particularly if those losses are substantial and appear they may be permanent, more and more people will close their business
– They will go to work for some one else – They will go into a different business
• Market supply decreases and forces prices up
– This process continues until people stop getting out
Trang 29• When economic profits become negative,
particularly if those losses are substantial and appear they may be permanent, more and more people will close their business
– They will go to work for some one else – They will go into a different business
Trang 30• When there are economic profits (short run)
more people are attracted into this type of business
• Market supply increases and forces prices
down
– This process continues until people stop getting in – Economic profits are zero at this point (long run) – No one else wants to enter or leave
Trang 31• When there are economic profits (short run)
more people are attracted into this type of business
• Market supply increases and forces prices
down
– This process continues until people stop getting in – Economic profits are zero at this point (long run) – No one else wants to enter or leave
S2
S1
P2
P1
Trang 32Industries
Output (in thousands)
200 180 160 140 120 100 80 60 40 20 0
Constant costs
ATC
Decreasing cost industries are characterized by firms operating on the declining segments of their ATC curves
They can take advantage of economies of scale (discounts for buying larger
quantities, declining AFC as output expands, lower cost from specialization, etc.)
Trang 33Industries
Output (in thousands)
200 180 160 140 120 100 80 60 40 20 0
Trang 34Industries
Output (in thousands)
200 180 160 140 120 100 80 60 40 20 0
Trang 35Industries
Output (in thousands)
200 180 160 140 120 100 80 60 40 20 0
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30/4,000,000 = .0000075
75 10,000,000
The individual firm’s output is between 0 & 30 units. The industry’s output is in the millions. This firm would have to grow and expand output to between 80,000 units and 150,000 units to have any influence on price. Once it did, perfect competition would no longer exist in this industry