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Ch. 12: Perfect Competition.

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Ch. 12: Perfect Competition. Selection of price and output Shut down decision in short run. Entry and exit behavior. Predicting the effects of a change in demand ... – PowerPoint PPT presentation

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Title: Ch. 12: Perfect Competition.


1
Ch. 12 Perfect Competition.
  • Selection of price and output
  • Shut down decision in short run.
  • Entry and exit behavior.
  • Predicting the effects of a change in demand,
    technological advance, or change in cost.
  • Efficiency of perfect competition

2
Perfect Competition
  • Perfect competition is an industry in which
  • Many firms sell identical products to many
    buyers.
  • No barriers to entry.
  • Established firms have no advantages over new
    ones.
  • Sellers and buyers are well informed about
    prices.
  • Perfect competition arises when
  • When firms minimum efficient scale is small
    relative to market demand
  • Homogeneous products only price matters to
    buyers.

3
Perfect Competition
  • In perfect competition, each firm is a price
    taker.
  • No single firm can influence the price
  • Each firms output is a perfect substitute for
    the output of the other firms,
  • Demand for each firms output is perfectly
    elastic.

4
Perfect Competition
  • Market demand and supply determine the price that
    the firm must take.
  • A firms marginal revenue is the change in TR
    resulting from a one-unit increase in the
    quantity sold.
  • In perfect competition, MRP.

5
Perfect Competition
  • Firmss goal maximize economic profit.
  • TR TC
  • TRPXQ
  • TCopportunity costs of production, including
    normal profit for the owner.

6
Profit Max. in Perfect Comp.
  • A perfectly competitive firm faces two
    constraints
  • A market constraint summarized by the market
    price and the firms revenue curves
  • A technology constraint summarized by firms
    product curves and cost curves.

7
Profit Max. in Perfect Comp.
  • 2 decisions in the short run
  • Whether to produce or to shut down.
  • If the decision is to produce, what quantity to
    produce.
  • A firms long-run decisions are
  • Whether to stay in the industry or leave it.
  • Whether to increase or decrease its plant size.

8
Profit Max. in Perfect Comp.
  • At low output levels, the firm incurs an
    economic lossit cant cover its fixed costs.
  • Profits maximized at 9 units of output.

9
Profit Max. in Perfect Comp.
  • Marginal Analysis
  • Because MR is constant and MC eventually
    increases as output increases, profit is
    maximized by producing the output at which
  • (P)MR MC

10
Profit Max. in Perfect Comp.
11
Profit Max. in Perfect Comp.
  • Profit (P-ATC)Q

12
Profit Max. in Perfect Comp.
  • SR decision to shut down.
  • P (P-ATC)Q
  • (P-AVC)Q TFC
  • If P lt minimum of AVC, the firm shuts down
    temporarily and incurs a loss equal to TFC.
  • If Pgt minimum of AVC, the firm produces the
    quantity at which PMC, even if profits are
    negative.

13
Profit Max. in Perfect Comp.
  • The Firms Short-Run Supply Curve
  • shows how the firms profit-maximizing output
    varies as the market price varies, other things
    remaining the same.
  • MC curve above minimum of AVC

14
Graphic representation of firms profit
maximizing output for various prices
15
  • SR Industry Supply Curve
  • The quantity supplied by the industry at any
    given price is the sum of the quantities supplied
    by all the firms in the industry at that price.
  • Entry of new firms shifts industry supply curve
    to the right
  • Exit of old firms shifts industry supply curve to
    the left.

16
LR adjustments
  • In SR, economic profits could be positive,
    negative or zero.
  • In the LR,
  • Firms enter if economic profits are positive
  • Firms exit if economic profits are negative.
  • No entry or exit if economic profits are zero.

17
LR adjustments
  • Effect of increase in demand on economic profits
    in LR
  • At LR equilibrium
  • PMCATC
  • P0
  • ATC is at a minimum

18
SR vs. LR Adjustments
  • Summary of effects of an increase in demand when
    starting from a LR equilibrium.

SR effect LR effect
Price
Firm output
Industry output
Number of firms
Profits
ATC
19
LR equilibrium
  • Long-run equilibrium occurs in a competitive
    industry when
  • P is zero, so firms have no incentive to enter
    or exit the industry.
  • LRATC is at its minimum, so firms cant reduce
    costs by changing plant size.

20
External Economies and Diseconomies
  • Constant cost industry
  • Industry output has no effect on a given firms
    ATC
  • External economies
  • decreasing cost industry
  • Firms costs fall as industry output rises
  • External diseconomies
  • Increasing cost industry
  • Firms costs rise as industry output rises

21
External Economics and Diseconomies
  • LR supply curve reflects how change in industry
    output affects ATC.
  • External economies ? LR supply upward
    sloping
  • External diseconomies ? LR supply downward
    sloping
  • Constant cost industry ? LR supply horizontal.

22
LR adjustment to change in demand with decreasing
cost industry
23
LR adjustment to change in demand with increasing
cost industry
24
Changes in Plant Size or adoption of new
technology
  • Firms change their production technology (or
    plant size) whenever doing so is profitable.
  • If ATC exceeds the minimum of LRATC, firms change
    their technology to lower costs and increase
    profits.
  • Suppose a new technology emerges that reduces
    LRATC at a higher level than previously.

25
Changes in Production Technology
  • Why cant a firm survive in LR at Q6?
  • Why is LR equilibrium at Q where LRATC is
    minimized?

26
Technological Advances
  • New-technology firms enter and old-technology
    firms either exit or adopt the new technology.
  • Optimal sized firm could be either larger or
    smaller
  • Industry supply increases and the industry
    supply curve shifts rightward.
  • The price falls and the quantity increases.
  • Eventually, a new long-run equilibrium emerges in
    which
  • all the firms use the new technology
  • the price has fallen to the minimum average total
    cost
  • each firm earns normal profit (zero economic
    profit)

27
Competition and Efficiency
  • Competitive equilibrium is efficient only if
    there are no external benefits or costs.
  • Positive externalities.
  • Negative externalities.
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