c h a p t e r eleven © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando & Yvonn Quijano Firms in Perfectly Competitive Markets

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 2 of 35 Firms in Perfectly Competitive Markets MARKET STRUCTURE CHARACTERISTIC PERFECT COMPETITION MONOPOLISTIC COMPETITIONOLIGOPOLYMONOPOLY Number of firms Type of product Ease of entry Examples of industries Many Identical High Wheat Apples Many Differentiated High Selling DVDs Restaurants Few Identical or differentiated Low Manufacturing computers Manufacturing automobiles One Unique Entry blocked First-class mail delivery Tap water The Four Market Structures 11 – 1

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 3 of 35 Perfectly Competitive Markets LEARNING OBJECTIVE 1 Perfectly competitive market A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, (3) no barriers to new firms entering the market.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 4 of 35 Perfectly Competitive Markets A Perfectly Competitive Firm Cannot Affect the Market Price Price taker A buyer or seller that is unable to affect the market price A Perfectly Competitive Firm Faces a Horizontal Demand Curve

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 5 of 35 How a Firm Maximizes Profit in a Perfectly Competitive Market Profit Total revenue minus total cost. Profit = TR - TC LEARNING OBJECTIVE The Market Demand for Wheat versus the Demand or One Farmer’s Wheat Don’t Confuse the Demand Curve for Farmer Douglas’s Wheat with the Market Demand Curve for Wheat

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 6 of 35 How a Firm Maximizes Profit in a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market Average revenue (AR) Total revenue divided by the number of units sold. Marginal revenue (MR) Change in total revenue from selling one more unit.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 7 of 35 How a Firm Maximizes Profit in a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market Farmer Douglas’s Revenue from Wheat Farming 11 – 2 NUMBER OF BUSHELS (Q) MARKET PRICE (PER BUSHEL) (P) TOTAL REVENUE (TR) AVERAGE REVENUE (AR) MARGINAL REVENUE (MR) $4 4 $ $4 4 - $4 4

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 8 of 35 How a Firm Maximizes Profit in a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market Farmer Douglas’s Profits from Wheat Farming 11 –3 QUANTITY (BUSHELS) (Q) TOTAL REVENUE (TR) TOTAL COSTS (TC) PROFIT (TR-TC) MARGINAL REVENUE (MR) MARGINAL COST (MC) $ $ $ $ $

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 9 of 35 How a Firm Maximizes Profit in a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market The Profit-Maximizing Level of Output

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 10 of 35 Profit = (P x Q)  TC Illustrating Profit or Loss on the Cost Curve Graph LEARNING OBJECTIVE 3 Profit = (P  ATC)Q Or

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 11 of 35 Showing a Profit on the Graph The Area of Maximum Profit Illustrating Profit or Loss on the Cost Curve Graph

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 12 of 35 Illustrating When a Firm Is Breaking Even or Operating at a Loss  P > ATC, which means the firm makes a profit  P = ATC, which means the firm breaks even (its total cost equals it total revenue)  P < ATC, which means the firm experiences losses A Firm Breaking Even and Experiencing Losses Illustrating Profit or Loss on the Cost Curve Graph

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 13 of 35 Deciding Whether to Produce or to Shut Down in the Short Run LEARNING OBJECTIVE 4 In the short run a firm suffering losses has two choices:  Continue to produce  Stop production by shutting down temporarily Sunk cost A cost that has already been paid and that cannot be recovered.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 14 of 35 The Supply Curve of the Firm in the Short Run The Firm’s Short-Run Supply Curve Shutdown point The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run. Deciding Whether to Produce or to Shut Down in the Short Run

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 15 of 35 “If Everyone Can Do It, You Can’t Make Money At It” – The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision Economic profit A firm’s revenues minus all its costs, implicit and explicit. Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 16 of 35 “If Everyone Can Do It, You Can’t Make Money At It” – The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision EXPLICIT COSTS Water Wages Organic fertilizer Electricity Payment on bank loan $25,000 $35,000 $14,000 $5,000 $6,000 IMPLICIT COSTS Foregone salary Opportunity cost of the $100,000 she has invested in her farm Total Cost $30,000 $10,000 $125,000 Farmer Appleseed’s Costs per Year 11 – 5

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 17 of 35 “If Everyone Can Do It, You Can’t Make Money At It” – The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision ECONOMIC PROFIT LEADS TO ENTRY OF NEW FIRMS The Effect of Entry on Economic Profits

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 18 of 35 “If Everyone Can Do It, You Can’t Make Money At It” – The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision ECONOMIC LOSSES LEAD TO EXIT OF FIRMS The Effect of Exit on Economic Losses

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 19 of 35 “If Everyone Can Do It, You Can’t Make Money At It” – The Entry and Exit of Firms in the Long Run Long-Run Equilibrium in a Perfectly Competitive Market Long-run competitive equilibrium The situation in which the entry and exit of firms have resulted in the typical firm just breaking even.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 20 of 35 “If Everyone Can Do It, You Can’t Make Money At It” – The Entry and Exit of Firms in the Long Run The Long-Run Supply Curve in a Perfectly Competitive Market Long-run supply curve A curve showing the relationship in the long run between market price and the quantity supplied.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 21 of 35 Perfect Competition and Efficiency LEARNING OBJECTIVE 6 Productive Efficiency Productive efficiency The situation in which a good or service is produced at the lowest possible cost.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 22 of 35 Perfect Competition and Efficiency Allocative Efficiency Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them:  The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold.  Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit.  Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 23 of 35 Perfect Competition and Efficiency Allocative Efficiency Allocative efficiency A state of the economy in which production reflects consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Firms in Perfectly Competitive Markets 24 of 35 Allocative efficiency Average revenue ( AR ) Economic loss Economic profit Long-run supply curve Marginal revenue Perfectly competitive market Price taker Productive efficiency Profit Shutdown point Sunk cost