Chapter 14 pp
- 1. Perfect Competition 14 Perfect Competition There’s no resting place for an enterprise in a competitive economy. — Alfred P. Sloan CHAPTER 14 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
- 2. Perfect Competition 14 A Perfectly Competitive Market • For a market to be perfectly competitive, six conditions must be met: 1. Both buyers and sellers are price takers – a price taker is a firm or individual who takes the price determined by market supply and demand as given 2. The number of firms is large – any one firm’s output compared to the market output is imperceptible and what one firm does has no influence on other firms • A perfectly competitive market is a market in which economic forces operate unimpeded 14-2
- 3. Perfect Competition 14 A Perfectly Competitive Market 3. There are no barriers to entry – barriers to entry are social, political, or economic impediments that prevent firms from entering a market 4. Firms’ products are identical – this requirement means that each firm’s output is indistinguishable from any other firm’s output 5. There is complete information – all consumers know all about the market such as prices, products, and available technology 6. Selling firms are profit-maximizing entrepreneurial firms – firms must seek maximum profit and only profit 14-3
- 4. Perfect Competition 14 Demand Curves for the Firm and the Industry P Q Market demand is downward sloping Market Supply Firm demand is perfectly elastic (horizontal) P0 Market Demand P Q P0 Firm Demand P = D = MR Q1 Q2 Q3 14-4
- 5. Perfect Competition 14 Profit Maximizing Level of Output • Marginal revenue (MR) is the change in total revenue associated with a change in quantity • A firm maximizes profit when marginal revenue equals marginal cost • The goal of the firm is to maximize profits, the difference between total revenue and total cost • Marginal cost (MC) is the change in total cost associated with a change in quantity 14-5
- 6. Perfect Competition 14 Profit Maximizing Level of Output If MR < MC, • a firm can increase profit by decreasing its output If MR > MC, • a firm can increase profit by increasing output • The profit-maximizing condition of a competitive firm is: MR = MC • For a competitive firm, MR = P • A firm maximizes total profit, not profit per unit 14-6
- 7. Perfect Competition 14 Marginal Cost, Marginal Revenue, and Price Table Price = MR ($) Q Marginal Cost ($) 35 0 28 20 16 14 12 17 22 30 40 54 35 1 35 2 35 3 35 4 35 5 35 6 35 7 35 8 35 9 35 10 If MC < P, increase production Profit maximizing quantity is where MC = P If MC > P, decrease production The profit-maximizing condition of a competitive firm is: MC = MR = P 14-7
- 8. Perfect Competition 14 Marginal Cost, Marginal Revenue, and Price Graph P Q Marginal Cost $35 P = D = MR MC < P, increase output to increase total profit MC = P at 8 units, total profit is maximized MC > P, decrease output to increase total profit MC = P 14-8
- 9. Perfect Competition 14 Total Revenue and Total Cost Table Q Total Revenue ($) Total Cost ($) Total Profit ($) 0 0 40 -40 1 35 68 -33 2 70 88 -18 3 105 104 1 4 140 118 22 5 175 130 45 6 210 147 63 7 245 169 76 8 280 199 81 9 315 239 76 10 350 293 57 Total profit is maximized at 8 units of output 14-9
- 10. Perfect Competition 14 Determining Profits Graphically: A Firm with Profit AVC MC Q P ATC Find output where MC = MR, this is the profit maximizing Q P = D = MR MC = MR Qprofit max Find profit per unit where the profit max Q intersects ATC ATC at Qprofit max P ATC Profits Since P>ATC at the profit maximizing quantity, this firm is earning profits 14-10
- 11. Perfect Competition 14 Determining Profits Graphically: The Shutdown Decision AVC MC Q P ATC Qprofit max PShut down P = D = MR • The shutdown point is the point below which the firm will be better off if it shuts down than it will if it stays in business • If P>min of AVC, then the firm will still produce, but earn a loss • If P<min of AVC, the firm will shut down • If a firm shuts down, it still has to pay its fixed costs 14-11
- 12. Perfect Competition 14 ATC Profits Short-Run Market Supply and Demand Graph P Q Market Supply P Market Demand P Q P P = D = MR MC ATC Qprofit max Market Firm 14-12
- 13. Perfect Competition 14 Long-Run Competitive Equilibrium • Profits create incentives for new firms to enter, market supply will increase, and the price will fall until zero profits are made • At long run equilibrium, economic profits are zero • The existence of losses will cause firms to leave the industry, market supply will decrease, and the price will increase until losses are zero 14-13
- 14. Perfect Competition 14 Long-Run Competitive Equilibrium • Normal profit is the amount the owners would have received in their next best alternative • Zero profit does not mean that the entrepreneur does not get anything for his efforts • Economic profits are profits above normal profits 14-14
- 15. Perfect Competition 14 SR Profits Market Response to an Increase in Demand Graph P Q S0(SR) P0 D0 P Q P0 MC ATC Q0,2 Market Firm S1(SR) D1 P1 1 P1 1 1 Q1 2 2 2 Q0 Q1 Q2 1 1 2 2 S(LR) 14-15