MOD 58-60: PERFECT COMPETITION MARKET STRUCTURES

TYPES OF MARKET STRUCTURES Perfect Competition Supply and Demand driven Monopoly One producer, no close substitutes Oligopoly Only a few firms Monopolistic Competition Large number of firms, differentiated products Ex: food

PERFECT COMPETITION What are some examples of perfect competition you can think of?

MARKET STRUCTURES: PERFECT COMPETITION Perfect Competition Low barriers of entry Large number of buyers and sellers Undifferentiated products Supply and demand driven Producers – produce at optimal output level (MC=MB) Price-takers – due to competition, perfectly comp. firms are price takers

MARKET STRUCTURES: PERFECT COMPETITION What does price-taker mean? Market Price = MR Profit is maximized at this point Price-taking firms optimal output rule Price-taking firms cannot influence the market with its actions Ex: if it sells more goods, will not affect price, etc.

MARKET STRUCTURES: PERFECT COMPETITION ONLY market where the firms are price-takers, in the others, consumers are price-takers

MARKET STRUCTURES: PERFECT COMPETITION

SUMMARY TR > TC, firm is profitable TR = TC, firm breaks even TR < TC, firm incurs a loss P > ATC, firm is profitable P = ATC, firm breaks even P < ATC, firm incurs a loss

MARKET STRUCTURES: PERFECT COMPETITION Interpreting Perfect Competition Graphs MC, ATC, and MRDARP Key components Market Price = MR. DARP Marginal revenue = Demand = Average revenue = Price MC = production costs (marginal) ATC = average total costs

Which point is the profit maximizing output? What does that mean? Which point is the minimum average total cost? What does that mean?

MARKET STRUCTURES: PERFECT COMPETITION

Short-Run production decisions Just because you are unprofitable in the short run does NOT mean you should shut down SR includes fixed costs SR – fixed costs should play NO ROLE in the decision They operate ALONG THE LINES of sunk costs but they are not sunk costs because they have to be PAID

MARKET STRUCTURES: PERFECT COMPETITION There is a firm shut down price Shut down price – the firm ceases production (SR) When MR. DARP is below minimum AVC SHUT DOWN ! Why? No level of output which creates revenue will cover variable costs So, profit is maximized by NOT producing at all

MARKET STRUCTURES: PERFECT COMPETITION

Profitability Condition (minimum ATC = break-even price) Result P > minimum ATCFirm profitable Entry into the industry in LR P = minimum ATCFirm breaks even No entry or exit from industry in LR P < minimum ATCFirm unprofitable Exit from industry in LR Production Condition (minimum AVC = shut-down price) Result P > minimum AVCFirm produces in the SR P < minimum ATC, firm covers VC and some FC P > minimum ATC, firm covers TC P = minimum AVCFirm indifferent between producing in SR or not Just covers VC P < minimum AVCFirm shuts down in SR Does not cover VC

MARKET STRUCTURES: PERFECT COMPETITION Perfect Competition and the Long Run Have been talking about the SR focusing on ceteris paribus and a single firm The Industry Supply Curve What happens to the industry when we look at price and total output?

SHORT RUN FOR A SINGLE FIRM

SHORT RUN INDUSTRY SUPPLY CURVE

MARKET STRUCTURES: PERFECT COMPETITION Effect on individual firm when firms enter/exit the industry? At first, when firms enter Process will continue until ALL firms break even and are making ZERO ECONOMIC PROFIT (min ATC) What happens to the supply curve in the LR as firms enter?

MARKET STRUCTURES: PERFECT COMPETITION