1. F ERNANDO Q UIJANO, Y VONN Q UIJANO, K YLE T HIEL & A PARNA S UBRAMANIAN PREPARED BY: © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez Perfect Competition

2. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 2 of 34 PERFECT COMPETITION perfectly competitive market A market with many sellers and buyers of a homogeneous product and no barriers to entry. price taker A buyer or seller that takes the market price as given.

3. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 3 of 34 PERFECT COMPETITION Here are the five features of a perfectly competitive market: 1 There are many sellers. 2 There are many buyers. 3 The product is homogeneous. 4 There are no barriers to market entry. 5 Both buyers and sellers are price takers.

4. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 4 of 34 COFFEE WARS Many of the upscale coffee houses, and their patrons, do not view Dunkin’ Donuts as competition. Others indicated they prefer Dunkin’ Donuts coffee over Starbucks. The new Dunkin’ Donuts outlets have a new image…more urban and upscale. Can this market accommodate a new entrant? Starbucks, the current heavyweight of the upscale coffee world with 8,600 stores, is being challenged by Dunkin’ Donuts. The doughnut chain currently maintains 4,400 stores but plans to open 10,000 more outlets by 2020. Extra Application 6 It is my belief that consumers buy the coffee and the atmosphere of the coffee house. Starbucks will view Dunkin’ Donuts as a competitive threat if the company believes they appeal to the same market. New entrants will push the supply curve to the right and result in a lower price. However, I believe Starbucks will attempt to reinforce its image as the upscale coffee house where higher income individuals should be seen. If this is the case, then the market is actually for coffee houses, and not coffee.

5. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 5 of 34 PREVIEW OF THE FOUR MARKET STRUCTURES 6.1 firm-specific demand curve A curve showing the relationship between the price charged by a specific firm and the quantity the firm can sell.

6. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 6 of 34 PREVIEW OF THE FOUR MARKET STRUCTURES 6.1  FIGURE 6.1 Monopoly Versus Perfect Competition

7. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 7 of 34 PREVIEW OF THE FOUR MARKET STRUCTURES 6.1

8. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 8 of 34 THE FIRM’S SHORT-RUN OUTPUT DECISION 6.2 The Total Approach: Computing Total Revenue and Total Cost

9. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 9 of 34 THE FIRM’S SHORT-RUN OUTPUT DECISION 6.2 The Total Approach: Computing Total Revenue and Total Cost ► FIGURE 6.2 Using the Total Approach to Choose an Output Level

10. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 10 of 34 THE FIRM’S SHORT-RUN OUTPUT DECISION 6.2 The Marginal Approach marginal revenue The change in total revenue from selling one more unit of output. marginal revenue = price To maximize profit, produce the quantity where price = marginal cost

11. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 11 of 34 THE FIRM’S SHORT-RUN OUTPUT DECISION 6.2 The Marginal Approach  FIGURE 6.3 The Marginal Approach to Picking an Output Level

12. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 12 of 34 THE FIRM’S SHORT-RUN OUTPUT DECISION 6.2 Economic Profit and the Break-Even Price economic profit = (price − average cost) × quantity produced break-even price The price at which economic profit is zero; price equals average total cost.

13. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 13 of 34 THE FIRM’S SHUT-DOWN DECISION 6.3 Total Revenue, Variable Cost, and the Shut-Down Decision operate if total revenue > variable cost shut down if total revenue < variable cost

14. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 14 of 34 THE FIRM’S SHUT-DOWN DECISION 6.3 Total Revenue, Variable Cost, and the Shut-Down Decision ► FIGURE 6.4 The Shut-Down Decision and the Shut-Down Price

15. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 15 of 34 THE FIRM’S SHUT-DOWN DECISION 6.3 The Shut-Down Price operate if price > average variable cost shut down if price < average variable cost shut-down price The price at which the firm is indifferent between operating and shutting down; equal to the minimum average variable cost.

16. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 16 of 34 THE FIRM’S SHUT-DOWN DECISION 6.3 Fixed Costs and Sunk Costs sunk cost A cost that a firm has already paid or committed to pay, so it cannot be recovered.

17. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 17 of 34 THE BREAK-EVEN PRICE FOR A CORN FARMER APPLYING THE CONCEPTS #1: What is the break-even price? To illustrate the notions of break-even and shut-down prices, let’s look at these prices for the typical corn farmer. The break-even, or zero-profit, price is $0.72 per bushel. At this price, the farmer will produce at the minimum point of the average total-cost curve, with the average cost equal to the market price of $0.72. At a higher price, the farmer will make a positive economic profit. The corn farmer’s shut-down price is $0.44. At a price between the shut-down price ($0.44) and the break-even price ($0.72), the farmer will lose money but will continue to operate at a loss because total revenue will exceed the variable cost of growing corn. In the long run, farmers will exit the market if the price stays below the break-even price of $0.72.

18. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 18 of 34 SHORT-RUN SUPPLY CURVES 6.4 The Firm’s Short-Run Supply Curve short-run supply curve A curve showing the relationship between the market price of a product and the quantity of output supplied by a firm in the short run.

19. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 19 of 34 SHORT-RUN SUPPLY CURVES 6.4 The Firm’s Short-Run Supply Curve  FIGURE 6.5 Short-Run Supply Curves

20. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 20 of 34 SHORT-RUN SUPPLY CURVES 6.4 The Short-Run Market Supply Curve short-run market supply curve A curve showing the relationship between market price and the quantity supplied in the short run.

21. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 21 of 34 SHORT-RUN SUPPLY CURVES 6.4 Market Equilibrium  FIGURE 6.6 Market Equilibrium

22. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 22 of 34 SHORT-RUN SUPPLY CURVES 6.4 Market Equilibrium For a short-run equilibrium, two conditions are satisfied: 1 At the market level, the quantity of the product supplied equals the quantity demanded. The demand curve intersects the short-run market supply curve at a price of $7 and a quantity of 600 shirts per minute (Panel A). 2The typical firm in the market maximizes its profit, given the market price. Given the market price of $7, each of the 100 firms maximizes profit by producing 6 shirts per minute (Panel B). The market reaches a long-run equilibrium when the two conditions for short-run equilibrium are met, and a third long-run condition holds as well. 3Each firm in the market earns zero economic profit, so there is no incentive for existing firms to leave the market and no incentive for other firms to enter the market.

23. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 23 of 34 WIRELESS WOMEN IN PAKISTAN APPLYING THE CONCEPTS #2: How do entry costs affect the number of firms in a market? In Pakistan, many poor villagers cannot afford their own phones, and phone service is provided by thousands of “wireless women,” entrepreneurs who invest $310 in wireless phone equipment (transceiver, battery, charger), a signboard, a calculator, and a stopwatch. They sell phone service to their neighbors, charging by the minute and second. On average, their net income is about $2 per day, about three times the average per capita income in Pakistan. The market for phone service has the features of a perfectly competitive market, with easy entry, a standardized good, and a large enough number of suppliers that each takes the market price as given. In contrast, to enter the phone business in the United States, your initial investment would be millions, or perhaps billions, of dollars, so the market for phone service is not perfectly competitive.

24. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 24 of 34 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY 6.5 long-run market supply curve A curve showing the relationship between the market price and quantity supplied in the long run. increasing-cost industry An industry in which the average cost of production increases as the total output of the industry increases; the long-run supply curve is positively sloped.

25. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 25 of 34 ORACLE’S QUEST FOR GREATER EFFICIENCY The reduction in work force could cost some Oracle employees their jobs as the company attempts to boost profits via the downsizing. The company’s cost-cutting moves are an attempt to compete with rival SAP in business application software. Shareholders are not overly impressed with Oracle stock closing only 20 cents a share higher after the announcement. Oracle Corporation’s recent takeover of rival Siebel Systems Inc. has spurred substantial job cuts. Oracle is expected to cut between 1,000 and 2,000 jobs that are primarily in functional areas that represent duplication of efforts. Oracle currently employs 51,000 original Oracle employees and the additional 4,700 Siebel employees. Extra Application 7 Oracle Corporation’s acquisition of Siebel has allowed the software firm to reduce average total costs via reduction in labor force. Many jobs in the now-merged company had substantial overlap and Oracle can reduce costs by eliminating duplicate positions. Oracle’s total output will be higher but the long-run average cost per unit should decline. Oracle will benefit from additional economies of scale as production and costs move from point a to point b.

26. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 26 of 34 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY 6.5 The average cost increases as the industry grows for two reasons: 1Increasing input price. As an industry grows, it competes with other industries for limited amounts of various inputs, and this competition drives up the prices of these inputs. 2Less productive inputs. A small industry will use only the most productive inputs, but as the industry grows, firms may be forced to use less productive inputs.

27. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 27 of 34 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY 6.5 Production Cost and Industry Size

28. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 28 of 34 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY 6.5 Drawing the Long-Run Market Supply Curve  FIGURE 6.7 Long-Run Market Supply Curve

29. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 29 of 34 SHORT-RUN AND LONG-RUN EFFECTS OF CHANGES IN DEMAND 6.6 The Short-Run Response to an Increase in Demand  FIGURE 6.8 Short-Run Effects of an Increase in Demand

30. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 30 of 34 SHORT-RUN AND LONG-RUN EFFECTS OF CHANGES IN DEMAND 6.6 The Long-Run Response to an Increase in Demand  FIGURE 6.9 Short-Run and Long-Run Effects of an Increase in Demand

31. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 31 of 34 In many communities, the rental-apartment industry is an increasing-cost industry. As the industry expands by building more apartments, competition is fierce among firms for the small amount of land zoned for apartments. ZONING, LAND PRICES, AND THE SUPPLY CURVE FOR APARTMENTS APPLYING THE CONCEPTS #5: When input prices increase with the total output of the industry, what are the implications for the market supply curve? What are the implications of zoning for a market that experiences an increase in demand? In the short run, the stock of housing is fixed. An increase in demand for apartments will increase the price of apartments (the monthly rent), and firms will convert some owner-occupied houses to rental apartments. In the long run, firms will enter the market by building more apartments. The increase in demand leads to a net increase in price because zoning restricts the supply of apartment land, leading to higher land prices and a higher cost of producing apartments.

32. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 32 of 34 LONG-RUN SUPPLY FOR A CONSTANT-COST INDUSTRY 6.7 constant-cost industry An industry in which the average cost of production is constant; the long- run supply curve is horizontal.

33. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 33 of 34 LONG-RUN SUPPLY FOR A CONSTANT-COST INDUSTRY 6.7 Long-Run Supply Curve for a Constant-Cost Industry  FIGURE 6.10 Long-Run Supply Curve for a Constant-Cost Industry

34. chapter © 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan Sheffrin Perez 34 of 34 LONG-RUN SUPPLY FOR A CONSTANT-COST INDUSTRY 6.7 Hurricane Andrew and the Price of Ice ► FIGURE 6.11 Hurricane Andrew and the Price of Ice