Ch. 11 : Firms in Perfectly Competitive Markets

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Ch. 11 Firms in Perfectly Competitive Markets

• ECONOMICS 2420

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Chapter Objectives

• Learn what characteristics make a market
  competitive

• Examine how competitive firms decide how much
  output to produce

• Examine how competitive firms decide when to shut
  down production temporarily ? Price AVC (SR)

• Examine how competitive firms decide whether to
  exit or enter a market ? Price gt minimum LRACgt
  enter Pricelt minimum LRACgt exit (LR)

• See how firm behavior determines a markets
  short-run and long-run supply decisions to
  achieve efficiency

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1. The four broad market structures are

• Perfect competition- family farm and stock
  market

• Monopoly- Local electric department, local gas
  company Microsoft in Windows OS?

• Monopolistic Competition- gas station, fast food
  restaurant, grocery stores, e-commerce

• Oligopoly- auto industry, steel industry

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2. Criteria for market classification

• The number of small firms in the industry

• The type of product firms produce- homogenous
  VS differentiated products

• Entry conditions into the industry (Easy VS
  Difficult)

• Free information about product price and
  availability

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3. Features of Perfection competition

• Large number of small producers

• Firms sell identical or homogenous product

• Easy entry into the industry

• Perfect information about price and product
  availability

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4a. The demand for a competitive firm is
perfectly elastic (horizontal) It implies
that the typical firm in the industry charges the
market determined price(each firm is so small and
has no influence on the price)
b. For a competitive firm the demand(D)PARMR.
Illustrate
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Total, Average , And Marginal Revenue For A
Competitive Firm
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5. SR Profit Maximization by the MRMC Rule A
numerical Example
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5. The objective of any business firm is to
maximize profit or minimizing losses. This
objective can be realized by producing the rate
of output for which the Marginal Revenue
Marginal Cost The firm must produce 5 units to
maximize profit Notice it is only at Q 5 that
is maximum. Why not at Q4?
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6. In the short-run, a competitive firm may make
profit, just break-even, even operate at a loss
if AVCltPriceltATC, go out of business if
priceltAVC.
a. The profit making case PricegtATC
b. The break-even case PriceATC
c. Loss minimization by staying in business
AVCltPriceltATC
d. Going out of business case PriceltAVC
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7. The short-run supply curve for a competitive
producer is the portion of its marginal cost
above the minimum point on the AVC. Illustrate.
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8. Perfectly competitive firms will operate at
maximum efficiency and produce at minimum cost
(LRAC) in the long run.

• Long run equilibrium for a typical competitive
  firm occurs
• when
• Price Marginal revenue Minimum LRAC
  LRMC.

b. In the LR, a competitive firm has zero
economic profit and zero economic losses
due to The free entry and exit of firms
into and out of the industry.
Therefore, there is neither an inducement for new
firms to enter nor for existing firms to exit
from the industry in the long-run. Why? If
they are not making profits, what is the
incentive to stay in business?
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9. The long run industry supply curve shows the
quantities that the industry supplies at
different prices after entry and exist of firms
is completed. It is
a. Horizontal supply for a constant cost industry
b. Upward sloping supply for an increasing cost
industry. c. Downward sloping supply for a
decreasing cost industry.
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10. The Performance of Competitive Markets
. Positive Aspects of Perfect Competition
Resources are efficiently allocated in perfectly
competitive markets because
a. Competition forces firms in this industry to
use a technology that yields the lowest possible
per unit cost (minimum LRAC) - Price minimum
LRAC gtTechnical efficiency or production
efficiency
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b. The equality of price and marginal cost
implies that competition leads to resources
allocation efficiency so firms produce what
consumers want. Price Marginal Costgt
Allocative efficiency
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Some Criticisms of Perfect Competition
(1) It provides little incentive for innovation
(2) It fails to capture the spillover costs and
benefits-externalities
(3) It leads to a lack of product variety
(identical products)
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THE END