Ch 8 - Perfect Competition

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University of Illinois, Chicago *

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Economics

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Nov 24, 2024

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Chapter 8 Perfect Competition
Agenda Four Market Models Perfect Competition • Total, Average and Marginal Revenue • Profit Maximization – Total Revenue – Total Cost Approach – Marginal Revenue – Marginal Cost Approach 2
Four Market Models Perfect Competition Monopolistic Competition Oligopoly Perfect Monopoly Market Structure Continuum 3
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Characteristics of the Four Market Models Characteristic Perfect Competition Monopolistic Competition Oligopoly Monopoly Number of firms A very large number Many Few One Type of product Standardized Differentiated Standardized or differentiated Unique; no close subs. Control over price None Some, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Considerable Conditions of entry Very easy, no obstacles Relatively easy Significant obstacles Blocked Nonprice Competition None Considerable emphasis on advertising, brand names, trademarks Typically a great deal, particularly with product differentiation Mostly public relation advertising Examples Agriculture Retail trade, dresses, shoes Steel, auto Local utilities 4
Perfect Competition: Characteristics • Very large numbers of sellers and buyers • Standardized (identical) product • Easy entry and exit • Price takers 5
Perfect Competition: Demand Curve If a firm is a Price Taker, • The Firm produces as much or as little as they want at the market price • Demand is a horizontal line at the market price Perfectly elastic demand 6
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The Perfectly Competitive Firm and the Industry • The market equilibrium price of a product is determined through the interaction of market supply and market demand • If a firm is a Price Taker, the Firm produces as much or as little as they want at the market price Demand is a horizontal line at the market price (Perfectly elastic demand) 7
Average, Total, and Marginal Revenue • Total Revenue TR = P X Q • Average Revenue AR = TR/Q Note that this is = P • Marginal Revenue Extra revenue from 1 more unit MR = ΔTR/ΔQ 8
A Perfectly Competitive Firm’s Demand and Revenue Curves Firm’s Demand Schedule Firm’s Revenue Data Q D TR MR $18 18 18 18 18 18 18 0 1 2 3 4 5 6 $0 P AR a) Draw the firm’s Individual Demand curve with Price on the y-axis and Quantity Demanded on the x-axis. b) Fill out the Total Revenue column (recall that TR=P*Q). Draw it on the graph. c) Fill out the Marginal Revenue column. Draw it on the graph. d) How are the Marginal Revenue and the product price related? 9
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The Perfectly Competitive Firm • Three questions: 1. Should the firm produce? 2. If so, what amount? 3. What economic profit (loss) will be realized? 10
Profit Maximization in the Short Run TR-TC Approach 1. Suppose that Jack and Jill own an apple orchard and their firm is operating in a perfectly competitive market. There are a large number of buyers and sellers in the market. This means that the firm is a price taking firm and that it has no control over the product price. Suppose that the price of a bushel of apples is $18.00. The table on the next slide shows the Total Revenue and the assumed fixed and variable cost constraints that the firm faces. a) Calculate the Total Costs. b) Calculate the profit. (Profit = Total Revenue – Total Cost). c) How many units should the firm produce? Why? d) Is this the short run or the long run? How do you know? 11
Profit Maximization in the Short Run TR-TC Approach Units of Output Product Price Total Revenue =P*Q Total Fixed Cost Total Variable Cost Total Cost =TFC+T VC Profit =TR-TC 0 $18 $0 $14 $0 1 $18 18 $14 16 2 $18 36 $14 22 3 $18 54 $14 30 4 $18 72 $14 42 5 $18 90 $14 58 6 $18 108 $14 78 12
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Profit Maximization in the Short Run MR-MC Approach Using the same Total Revenue and Total Cost a) Calculate the marginal revenue. b) Calculate the marginal cost of producing each unit of output. c) Can you see a relationship between marginal cost, marginal revenue, and the profit maximizing quantity of production? Units of Output Total Revenue Total Cost Marginal Revenue Marginal Cost Profit 0 $0 $14 -14 1 18 30 -12 2 36 36 0 3 54 44 10 4 72 56 16 5 90 72 18 6 108 92 16 13
Profit Maximization in the Short Run Graph MR and MC • For a perfectly competitive firm, the marginal revenue (MR) curve is a horizontal straight line because it is equal to the price of the good, which is determined by the market • The marginal cost (MC) curve is sometimes first downward-sloping, if there is a region of increasing marginal returns at low levels of output, but is eventually upward-sloping at higher levels of output as diminishing marginal returns kick in 14
When is Production Profitable? • if MR > A TC , the firm is profitable • If MR = ATC , the firm breaks even • If MR < A TC , the firm incurs a loss loss minimization • If MR < AV C , the firm should shutdown 15
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Profit (Loss) in the Short Run Three cases: 1. Price intersects marginal cost above the average cost curve – Since price is greater than average cost, the firm is making a profit 2. Price intersects marginal cost at the minimum point of the average cost curve – Since price is equal to average cost, the firm is breaking even 3. Price intersects marginal cost below the average cost curve – Since price is less than average cost, the firm is making a loss 16
Case1: MR-MC Approach Suppose a competitive firm's cost information is as shown in the table below. Its total fixed cost is $9.00. Output Marginal Cost Average Variable Cost Average Total Cost Marginal Revenue 0 1 $ 8.00 $8.00 $17.00 2 7.00 7.50 12.00 3 6.00 7.00 10.00 4 5.00 6.50 8.75 5 6.00 6.40 8.20 6 7.00 6.50 8.00 7 8.00 6.71 8.00 8 9.00 7.00 8.13 9 10.00 7.33 8.33 10 11.00 7.70 8.60 Suppose the firm sells its output at a price of $9.10. a) What is the firm's marginal revenue (MR)? b) Compare MR to marginal cost (MC) to determine the firm's profit maximizing (loss-minimizing) output level c) What is the firm's per-unit profit (loss) at this output level? d) What is the firm's total profit (loss) at this output level? 17
Graph Case1 18
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Case2: MR-MC Approach (continued) Now assume the price has fallen to $7.10 Output Marginal Cost Average Variable Cost Average Total Cost Marginal Revenue 0 1 $ 8.00 $8.00 $17.00 2 7.00 7.50 12.00 3 6.00 7.00 10.00 4 5.00 6.50 8.75 5 6.00 6.40 8.20 6 7.00 6.50 8.00 7 8.00 6.71 8.00 8 9.00 7.00 8.13 9 10.00 7.33 8.33 10 11.00 7.70 8.60 a) What is the firm's marginal revenue (MR)? b) Compare MR to marginal cost (MC) to determine the firm's profit maximizing (loss-minimizing) output level. c) What is the firm's per-unit profit (loss) at this output level? d) What is the firm's total profit (loss) at this output level? e) Should the firm stay in business? 19
Graph Case2 20
Case3: MR-MC Approach (continued) Now assume the price has fallen to $6.10 Output Marginal Cost Average Variable Cost Average Total Cost Marginal Revenue 0 1 $ 8.00 $8.00 $17.00 2 7.00 7.50 12.00 3 6.00 7.00 10.00 4 5.00 6.50 8.75 5 6.00 6.40 8.20 6 7.00 6.50 8.00 7 8.00 6.71 8.00 8 9.00 7.00 8.13 9 10.00 7.33 8.33 10 11.00 7.70 8.60 a) What is the firm's marginal revenue (MR)? b) Compare MR to marginal cost (MC) to determine the firm's profit maximizing (loss-minimizing) output level. c) What is the firm's per-unit profit (loss) at this output level? d) What is the firm's total profit (loss) at this output level? e) Should the firm stay in business? 21
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Graph Case3 22
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The Long Run in Pure Competition • In the long run: − Firms can expand or contract capacity − Firms enter and exit the industry • Assume: – Identical costs – Constant-cost industry • Entry and exit of firms do not affect resource prices 23
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Long-Run Equilibrium • Entry eliminates profits − Firms enter − Supply increases − Price falls • Exit eliminates losses − Firms exit − Supply decreases − Price rises 24
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Long Run Supply? • Consider the two graphs below: – Graph A represents a typical firm in a purely competitive industry. – Graph B represents the supply and demand conditions in that industry . • In the long run, what will happen to price, profit, the supply curve, and the number of firms in the industry? 25
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Pure Competition and Efficiency • In the long run, efficiency is achieved • Productive efficiency − Producing where P = min. ATC • Allocative efficiency − Producing where P = MC 26
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