Chapter 10 Perfect Competition

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Chapter 10/ Perfect Competition

• Recall Perfect competition is a firm behavior
  that occurs
• when many firms produce identical products and
  entry is
• easy. Characteristics of perfect competition
• Assumptions
• There are many sellers.
• The products sold by the firms in the industry
  are identical. Thus, no need to advertise
• Entry into and exit from the market are easy,
  and there are many potential entrants.
• Buyers (consumers) and sellers (firms) have
  perfect information.
• Transactions costs are negligible

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Profit Maximization Price Taker

• Profit is maximized when MRMC.
• If the cost of producing one more unit is less
  than the revenue it generates, then profit is
  available for the firm that increases production
  by one unit OR if MC
• If the cost of producing one more unit is more
  than the revenue it generates, then increasing
  production reduces profit.
• Thus the firm will stop increasing production at
  the point at which it stops being profitable to
  do sowhen MRMC.
• Graphically, this occurs where the MC curve cross
  the MR curve from below.
• Price Taker
• A firm in a perfectly competitive market is a
  price taker because (a) the price of the product
  is determined by market supply and demand
  Industry, and (b) the individual firm can do
  nothing to change that price.
• The result is that the individual firm perceives
  the demand curve for its product as being
  perfectly horizontal. Thus, P MR horizontal
  demand with

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Market Supply and Demandand Single-Firm Demand
Price Taker
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Profit MaximizationGraphical Analysis
? (P-ATC) x Q (1.00 0.87)9 1.17 Profit
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Profit Maximization The Numbers
MRMC
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Determining Profit or Loss

• MRMC is the profit-maximizing or loss-minimizing
  output level. This rule is true regardless of
  market structure (under PC, Monopoly,
  Monopolistic Comp and Oligopoly)
• Profit or loss is determined by finding the
  quantity at which the marginal-revenue curve
  equals the marginal-cost curve (i.e. MR MC)
• If the demand curve (PdMR) is above the ATC
  curve, the firm is making a profit. If the ATC
  curve exceeds the price line, the firm is
  suffering a loss.

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Loss Minimization
Average cost of a unit of output
Market price falls
Revenue generated by a unit of output
At P2 0.70, p (P ATC) x Q (0.70 0.87) 6
-1.02 loss
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Shutdown Price

• Minimizing Loss
• Shutdown price the minimum point of the
  average-variable-cost (AVC) curve.
• Break-even price A price that is equal to the
  minimum point of the average-total-cost (ATC)
  curve. At this price, economic profit is zero.
• Recall MC above the minimum AVC is the firms
  Supply Curve (S)

ATC AVC AFC
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The Long Run

• The short run is a timeframe in which at least
  one of the factors is fixed Q f (L,K) where K
  is fixed.
• Exit and entry are long-run phenomena.
• In the long run, all quantities of
  resources/factors/inputs can be changed, Q f
  (L, K)
• Normal Profit in the Long Run
• Entry and exit occur whenever firms are earning
  more or less than normal profit (zero economic
  profit).
• If firms are earning more than normal profit,
  other firms will have an incentive to enter the
  market Entry
• If firms are earning less than normal profit,
  firms in the industry will have an incentive to
  exit the market Exit

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Economic Profit in the Long Run
At P1.50, p (P-ATC) x Q (1.50-1.00) x10 5
-ENTRY
Entry
S2
S3
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The Predictions of the Model of Perfect
Competition

• A zero economic profit (p0 )is a normal
  accounting profit, or just normal profit.
• Firms produce where marginal cost equals price
  (PMC)
• No one could be made better off without making
  someone else worse off. Economists refer to this
  result as economic efficiency or Pareto
  efficiency.

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Consumer Welfare Producer Surplus

• Definition of welfare
• Most people welfare government payments to
  poor people
• Economists welfare well-being of various
  groups such as consumers and producers
• Consumer surplus the difference between what the
  consumers would have been willing and able to pay
  for a product and the price they actually have to
  pay to buy the product. We measure consumer
  welfare in dollars
• Easier to measure than utility
• Can compare dollars across individuals
• Measuring Consumer Welfare (CS) CS from a good
• Benefit a consumer gets from consuming it (in )
  minus its price OR
• How much more you would be willing to pay than
  you did pay for a good
• The demand curve contains this information
• The demand curve reflects a consumers marginal
  willingness to pay --- the amount a consumer
  will pay for an extra unit.

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Consumer and Producer Surplus

• Producer surplus the difference between the
  price firms would have been willing and able to
  accept for their products and the price they
  actually receive for them.
• Measurement -- suppliers gain from participating
  in a market
• Difference between the amount for which good
  sells and the minimum necessary for the seller to
  produce the good OR
• Minimum amount a seller must receive to be
  willing to produce is the firms avoidable cost
  (shut-down rule), i.e. above where P AVC

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Producer and Consumer Surplus
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Rent Control and Market Efficiency