Perfect Competition

Review Identify the 4 Market Structures Identify the characteristics of perfect competition Why is a perfectly competitive firm a “price taker”? Explain why perfectly competitive firms make little profit How do ALL firms determine what output to produce? Draw a perfectly competitive firm producing 10 units at a price of $10 making a profit of $30 Draw and label a perfectly competitive firm making a loss. On your graph, identify the shut down point List 10 words that rhyme with the word “great”

Side-by-side graph for perfectly completive industry and firm. Is the firm making a profit or a loss? Why? P S P MC ATC MR=D $15 $15 AVC D Q 5000 8 Q Firm (price taker) Industry 3

Where is the profit maximization point? How do you know? What output should be produced? What is TR? What is TC? How much is the profit or loss? Where is the Shutdown Point? $25 20 15 10 MC MR=P Profit ATC Cost and Revenue AVC Total Revenue Total Cost 1 2 3 4 5 6 7 8 9 10

Supply Revisited 5

Marginal Cost and Supply As price increases, the quantity increases $50 45 40 35 30 25 20 15 10 5 MC ATC MR5 Cost and Revenue AVC MR4 MR3 MR2 MR1 Q 1 2 3 4 5 6 7 9 6

MC above AVC is the supply curve Marginal Cost and Supply When price increases, quantity increases When price decrease, quantity decreases $50 45 40 35 30 25 20 15 10 5 MC = Supply ATC Cost and Revenue AVC Q 1 2 3 4 5 6 7 9 7

Marginal Cost and Supply What if variable costs increase (ex: tax)? MC2=Supply2 $50 45 40 35 30 25 20 15 10 5 MC1=Supply1 AVC Cost and Revenue AVC When MC increases, SUPPLY decrease Q 1 2 3 4 5 6 7 9 8

Marginal Cost and Supply What if variable costs decrease (ex: subsidy)? MC1=Supply1 $50 45 40 35 30 25 20 15 10 5 MC2=Supply2 AVC Cost and Revenue AVC When MC decreases, SUPPLY increases Q 1 2 3 4 5 6 7 9 9

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?

(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.

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 12

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 13

Going from Long-Run to Short-Run 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 5000 6000 8 Q Industry Firm 15

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 16

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 17

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 18

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 19

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 20

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 21

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 22

Going from Long-Run to Long-Run 23

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 24

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 25

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 26

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 27

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

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 30

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

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

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

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

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.

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

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

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

Long-Run Equilibrium P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! MC D=MR Price P P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! Q Quantity 39