Unit 3: Costs of Production and Perfect Competition Copyright ACDC Leadership 2015

Law of Demin. Marginal Returns Fixed Cost Low Barriers Price Taker NAME THAT CONCEPT Law of Demin. Marginal Returns Fixed Cost Low Barriers Price Taker MR = MC Copyright ACDC Leadership 2015

Variable Costs Shut Down Rule MR=D=AR=P (Mr. Darp) Normal Profit NAME THAT CONCEPT Variable Costs Shut Down Rule MR=D=AR=P (Mr. Darp) Normal Profit Economies of Scale Copyright ACDC Leadership 2015

Review Draw and label a perfectly competitive firm making a profit Draw and label a perfectly competitive firm making a loss Why is that firm considered a “price taker”? How do firms determine what output to produce? On your graph, identify the shut down point On your graph, identify the firms supply curve What happens in the industry if there is a profit? What happens in the industry if there is a loss? List 10 rides at Disneyland

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Imperfect Competition Characteristics of Perfect Competition: Examples: Corn, Strawberries, Milk, etc. Many small firms Identical products (perfect substitutes) Low Barriers- Easy for firms to enter and exit the industry Seller has no need to advertise Firms are “Price Takers” The seller has NO control over price. Copyright ACDC Leadership 2015

Shifting Cost Curves A change in fixed costs change ATC and AFC (but not MC) A change in variable costs change ATC, AVC, and MC Copyright ACDC Leadership 2015

Changes in fixed costs don’t change output 28. If the current price for the perfectly competitive firm represented in Figure 1 is $10.00, what would be the result of an increase in fixed cost on the firm’s profit maximizing price and quantity?   A. Price increase and Quantity increase B. Price increase and Quantity decrease C. Price constant and Quantity constant D. Price decrease and Quantity decrease E. Price decrease and Quantity increase Changes in fixed costs don’t change output 28. C

Changes in variable costs change output 50. D Changes in variable costs change output Copyright ACDC Leadership 2015

Efficiency Copyright ACDC Leadership 2015

1. Productive Efficiency 2. Allocative 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 10 Copyright ACDC Leadership 2015

Graphically it is where price equals the minimum ATC Productive Efficiency- Producing at the lowest possible cost (minimum amount of resources are being used) Graphically it is where price equals the minimum ATC Allocative Efficiency- Producing at the amount most desired by society (allocating resources towards the products society wants) Graphically it is where price equals marginal cost 11 Copyright ACDC Leadership 2015

Short-Run Profit Not Productively Efficient MC MR=D=AR=P $10 ATC Notice that Q1 is NOT being made at the lowest possible cost (ATC not at lowest point). Q Q1

NOT Productively Efficient Short-Run Profit NOT Productively Efficient P MC MR=D=AR=P $10 $5 ATC At Q2, the price is greater than the MC so society wants more output produced Q Q2

Allocatively Efficient Short-Run Profit Allocatively Efficient P MC MR=D=AR=P $10 ATC Notice that the price people are willing to pay equals the additional cost to produce Q1 (Price = MC) Q Q1

Not Productively Efficient Short-Run Loss Not Productively Efficient P MC ATC MR=D=AR=P $5 Firms won’t produce Q2 Q 15 Copyright ACDC Leadership 2015

Long-Run Equilibrium Productively Efficient in the Long-Run MC ATC $8 MR=D=AR=P In the long-run, Q2 IS being made at the lowest possible cost (ATC at lowest point) Q3 Q

competitive profit maximizing firm is always allocatively efficient Long-Run Equilibrium P MC ATC $8 MR=D=AR=P A perfectly competitive profit maximizing firm is always allocatively efficient Q3 Q

Summary Perfectly competitive firms are allocatively and productively efficient in the long-run In the short-run, they are always allocatively efficient, but they are not productively efficient. 18 Copyright ACDC Leadership 2015

3.7 Homework Continued Draw a correctly labeled graph for a purely competitive firm in long-run equilibrium. Show the profit-maximizing level of output.