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Perfect Competition 14 Perfect Competition Theres no resting place for an enterprise in a competitive economy. Alfred P. Sloan CHAPTER 14 Copyright © 2010.

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Presentation on theme: "Perfect Competition 14 Perfect Competition Theres no resting place for an enterprise in a competitive economy. Alfred P. Sloan CHAPTER 14 Copyright © 2010."— Presentation transcript:

1 Perfect Competition 14 Perfect Competition Theres 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 firms 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 firms output is indistinguishable from any other firms 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) P0P0 Market Demand P Q P0P0 Firm Demand P = D = MR Q1Q1 Q2Q2 Q3Q3 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 ($)QMarginal Cost ($) 350 28 20 16 14 12 17 22 30 40 54 351 2 3 4 5 6 7 8 9 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 QTotal Revenue ($)Total Cost ($)Total Profit ($) 0 0 40-40 1 35 68-33 2 70 88-18 3105104 1 4140118 22 5175130 45 6210147 63 7245169 76 8280199 81 9315239 76 10350293 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 Q profit max Find profit per unit where the profit max Q intersects ATC ATC at Q profit 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 Q profit max P Shut 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 { "@context": "http://schema.org", "@type": "ImageObject", "contentUrl": "http://images.slideplayer.com/684756/2/slides/slide_10.jpg", "name": "Perfect Competition 14 Determining Profits Graphically: The Shutdown Decision AVC MC Q P ATC Q profit max P Shut 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 Pmin of AVC, then the firm will still produce, but earn a loss If P

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 Q profit max MarketFirm 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 S 0(SR) P0P0 D0D0 P Q P0P0 MC ATC Q 0,2 MarketFirm S 1(SR) D1D1 P1P1 1 P1P1 11 Q1Q1 2 22 Q0Q0 Q1Q1 Q2Q2 1 1 2 2 S (LR) 14-15


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