Perfect Competition

FOUR MARKET MODELS Characteristics of Pure Competition: Many small firms Identical products (perfect substitutes) Firms are “Price Takers” Easy for firms to enter and exit the industry No control over price. No need to advertise Pure Competition Monopolistic Competition Pure Monopoly Oligopoly Market Structure Continuum

Review Why is a perfectly competitive firm a price taker? How do firms determine what output to produce? Draw and label a perfectly competitive firm producing 10 units making a profit of $30 Draw and label a perfectly competitive firm producing 10 units making a loss of $30 On your graph, identify the firms supply curve On your graph, identify the shut down point What happens in the industry if there is a profit? What happens in the industry if there is a loss? Draw a perfectly competitive firm in long run equilibrium List 10 words that rhyme with the word “great”

The Competitive Firm is a Price Taker Price is set by the Industry Is the firm making a profit or a loss? Why? P S P MC ATC Loss D=MR $10 $10 D 400 Q 8 Q Firm (price taker) Industry

How much is the profit or loss? $50 Where is the Shutdown Price? $22 What is TR? $300 What is TC? $250 Profit/Loss per unit? $5 How much is the profit or loss? $50 Where is the Shutdown Price? $22 $35 30 25 20 MC MR=P ATC Cost and Revenue AVC 22 1 2 3 4 5 6 7 8 9 10

Perfect Competition in the Long-Run You are a wheat farmer. You learn that there is a more profit in making corn. What do you do in the long run? 6

(No Economic Profit=Normal Profit) In the Long-run… Firms will enter if there is profit Firms will leave if there is loss So, ALL firms break even, they make NO economic profit (No Economic Profit=Normal Profit) In long run equilibrium a perfectly competitive firm is EXTREMELY efficient. 7

Is the firm making a profit or a loss? Why? Side-by-side graph for perfectly completive industry and firm in the LONG RUN Is the firm making a profit or a loss? Why? P S P MC ATC MR=D $15 $15 D Q 5000 8 Q Firm (price taker) Industry 8

Firm in Long-Run Equilibrium Price = MC = Minimum ATC Firm making a normal profit P MC ATC $15 MR=D There is no incentive to enter or leave the industry TC = TR 8 Q 9 9

Going from Long-Run to Short-Run 10

Is this the short or the long run? Why? What will firms do in the long run? What happens to P and Q in the industry? What happens to P and Q in the firm? P S P MC ATC $15 $15 MR=D D Q 5000 6000 8 Q Industry Firm 11

Firms enter to earn profit so supply increases in the industry Price decreases and quantity increases P S P MC S1 ATC $15 $15 MR=D $10 D Q 5000 6000 8 Q Industry Firm 12

Price falls for the firm because they are price takers. Price decreases and quantity decreases P S P MC S1 ATC $15 $15 MR=D $10 $10 MR1=D1 D Q 5000 6000 5 8 Q Industry Firm 13

New Long Run Equilibrium at $10 Price Zero Economic Profit P P MC S1 ATC $10 $10 MR1=D1 D Q 5000 6000 5 Q Industry Firm 14

Is this the short or the long run? Why? What will firms do in the long run? What happens to P and Q in the industry? What happens to P and Q in the firm? P S P MC ATC $15 $15 MR=D D Q 4000 5000 8 Q Industry Firm 15

Firms leave to avoid losses so supply decreases in the industry Price increases and quantity decreases S1 P S P MC ATC $20 $15 $15 MR=D D Q 4000 5000 8 Q Industry Firm 16

Price increase for the firm because they are price takers. Price increases and quantity increases S1 P S P MC ATC $20 $20 MR1=D1 $15 $15 MR=D D Q 4000 5000 8 9 Q Industry Firm 17

New Long Run Equilibrium at $20 Price Zero Economic Profit S1 P P MC ATC $20 $20 MR1=D1 D Q 9 4000 Q Industry Firm 18

Going from Long-Run to Long-Run 19

Currently in Long-Run Equilibrium If demand increases, what happens in the short-run and how does it return to the long run? P S P MC ATC MR1=D1 $15 $15 MR=D D Q 5000 8 Q Industry Firm 20

Demand Increases The price increases and quantity increases Profit is made in the short-run P S P MC ATC $20 $20 MR1=D1 $15 $15 MR=D D1 D Q 5000 8 9 Q Industry Firm 21

Firms enter to earn profit so supply increases in the industry Price Returns to $15 P S S1 P MC ATC $20 $20 MR1=D1 $15 $15 MR=D D1 D Q 5000 7000 8 9 Q Industry Firm 22

Back to Long-Run Equilibrium The only thing that changed from long-run to long-run is quantity in the industry P S1 P MC ATC $15 $15 MR=D D1 D Q 7000 8 Q Industry Firm 23

Efficiency

1. Productive Efficiency 2. Allocative Efficiency PURE COMPETITION AND EFFICIENCY In general, efficiency is the optimal use of societies scarce resources Perfect Competition forces producers to use limited resources to their fullest. Inefficient firms have higher costs and are the first to leave the industry. Perfectly competitive industries are extremely efficient There are two kinds of efficiency: 1. Productive Efficiency 2. Allocative Efficiency 25

Efficiency Revisited Productive Efficient combinations are A through D Which points are productively efficient? Which are allocatively efficient? 14 12 10 8 6 4 2 Productive Efficient combinations are A through D (they are produced at the lowest cost) A B G Bikes Allocative Efficient combinations depend on the wants of society C E F D 0 2 4 6 8 10 Computers 26

Productive Efficiency The production of a good in a least costly way. (Minimum amount of resources are being used) Graphically it is where… Price = Minimum ATC 27

Short-Run MC ATC D=MR Price Profit Price P Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point). Q Quantity 28

Short-Run MC ATC Price D=MR Quantity P Q Loss D=MR Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point). Q Quantity 29

Long-Run Equilibrium MC ATC Price D=MR Notice that the product is being made at the lowest possible cost (Minimum ATC) Q Quantity 30

Why? Price represents the benefit people get from a product. Allocative Efficiency Producers are allocating resources to make the products most wanted by society. Graphically it is where… Price = MC Why? Price represents the benefit people get from a product. 31

Optimal amount being produced Long-Run Equilibrium MC MR P Price Optimal amount being produced The marginal benefit to society (as measured by the price) equals the marginal cost. Q Quantity 32

What if the firm makes 15 units? MC MR $5 Price The marginal benefit to society is greater the marginal cost. Not enough produced. Society wants more $3 15 20 Underallocation of resources Quantity 33

What if the firm makes 22 units? MC $7 MR $5 Price The marginal benefit to society is less than the marginal cost. Too much Produced. Society wants less 20 22 Overallocation of resources Quantity 34

Long-Run Equilibrium P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! MC D=MR Price P P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! Q Quantity 35