SAYRE | MORRIS Seventh Edition Perfect Competition CHAPTER 8 8-1© 2012 McGraw-Hill Ryerson Limited

Learning Objectives: Perfect Competition LO1: Distinguish among a firm, an industry, and a market LO2: Explain what is meant by perfect competition and the market system LO3: Use two approaches to explain how a firm might maximize its profits LO4: explain what is meant by break-even price and shutdown price CHAPTER 8 8-2© 2012 McGraw-Hill Ryerson Limited

Learning Objectives: Perfect Competition LO5: Explain how a firm’s supply curve is derived LO6: Explain the effect of a change in market demand or market supply on both the industry and the firm CHAPTER 8 8-3© 2012 McGraw-Hill Ryerson Limited

Industry a group of producers Market the interaction of both producers and consumers Perfect Competition a market in which all buyers and sellers are price takers 8-4© 2012 McGraw-Hill Ryerson Limited LO1

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Self-Test 8-6© 2012 McGraw-Hill Ryerson Limited In what type of market will you find the following types of firms/products? a)Hairdressing salons. b)Industrial chemicals in Canada. c)Commercial breweries in Canada. d)World market for coffee. e)Rogers Cable in Ontario. LO1

Self-Test 8-7© 2012 McGraw-Hill Ryerson Limited In what type of market will you find the following types of firms/products? a)Hairdressing salons. b)Industrial chemicals in Canada. c)Commercial breweries in Canada. d)World market for coffee. e)Rogers Cable in Ontario. LO1 monopolistic competition (undifferentiated) oligopoly (differentiated) oligopoly perfect competition monopoly

Conditions for Perfect Competition 1.many small buyers and sellers all of whom are price takers 2.no preferences shown 3.easy entry and exit by both buyers and sellers 4.the same market information available to all 8-8© 2012 McGraw-Hill Ryerson Limited LO2

Conditions for a Market System 1.extensive specialization and trade, 2.perfect competition, 3.private ownership of productive resources, and 4.a legal and social foundation 8-9© 2012 McGraw-Hill Ryerson Limited LO2

Self-Test 8-10© 2012 McGraw-Hill Ryerson Limited In what way(s) is the stock market a good example of perfect competition? In what way(s) is it a bad example? LO2

Self-Test 8-11© 2012 McGraw-Hill Ryerson Limited In what way(s) is the stock market a good example of perfect competition? In what way(s) is it a bad example? LO2 The stock market is a good example of perfect competition because there are many (millions) of buyers and sellers, the products sold are homogeneous and there is a great deal of information available about products; on the other hand, some of the buyers and sellers are big enough to affect prices, there is not equal access to information (insider trading), and there is not free entry into the market (you need to hire a broker to buy shares).

8-12© 2012 McGraw-Hill Ryerson Limited LO3 The Competitive Industry and Firm

Total Revenue total quantity sold (Q) times price (P) Average Revenue the amount of revenue received per unit sold Marginal Revenue the extra revenue derived from one more unit 8-13© 2012 McGraw-Hill Ryerson Limited LO3

8-14© 2012 McGraw-Hill Ryerson Limited LO3 Given a perfectly elastic demand curve, Price  AR = MR

8-15© 2012 McGraw-Hill Ryerson Limited LO3

Total Profit the difference between total revenue and total costs: T   TR  TC A firm will maximize profit when (Total Revenue  Total Cost) is greatest. Break-even Output the level of output at which the sales revenue of the firm just covers fixed and variable costs, including normal profit 8-16© 2012 McGraw-Hill Ryerson Limited LO3 Profit and Output

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8-19© 2012 McGraw-Hill Ryerson Limited LO3 Marginal Approach to Profit If MR > MC →produce more If MR < MC →produce less To maximize total profit, the firm should increase production to the point at which: MR = MC

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Self-Test 8-23© 2012 McGraw-Hill Ryerson Limited Given the data for Marshall’s Meat Ltd., calculate total profits at each output. What are break-even and profit-maximizing outputs? LO3 QPTRTCTп

Self-Test 8-24© 2012 McGraw-Hill Ryerson Limited Given the data for Marshall’s Meat Ltd., calculate total profits at each output. What are break-even and profit-maximizing outputs? LO3 QPTRTCTп Break-even outputs: 5 and 7; Profit maximizing output: 6

Self-Test 8-25© 2012 McGraw-Hill Ryerson Limited The following data is for Garden Pots Ltd. If the price of a pot is $20, what are the break-even levels of output and what is the profit-maximizing output? Output (Q)Average Cost (AC)Marginal Cost (MC) 0// 1$45$ LO3

Self-Test 8-26© 2012 McGraw-Hill Ryerson Limited The following data is for Garden Pots Ltd. If the price of a pot is $20, what are the break-even levels of output and what is the profit-maximizing output? Output (Q)Average Cost (AC)Marginal Cost (MC) 0// 1$45$ LO3 Break-even outputs at 3 and 6. (These are the ouputs at which P = AC.) Profit-maximizing output is 5. (This is where P = MC.)

Break-even Price the price at which the firm makes only normal profits; that is, makes zero economic profits As long as the losses from production are less than total fixed costs, the firm should continue to produce Shutdown Price the price that is just sufficient to cover a firm’s variable costs 8-27© 2012 McGraw-Hill Ryerson Limited LO4 Break-even and Shutdown

Self-Test 8-28© 2012 McGraw-Hill Ryerson Limited The accompanying graph shows the costs for a perfectly competitive firm. a)What is the break-even price? b)What is the shutdown price? LO4

Self-Test 8-29© 2012 McGraw-Hill Ryerson Limited The accompanying graph shows the costs for a perfectly competitive firm. a)What is the break-even price? b)What is the shutdown price? LO4 a) Break-even price is $140 (the minimum value of the AC). b) Shutdown price is $100 (the minimum value of the AVC).

The supply curve for a firm is that portion of its MC curve that lies above its average variable cost curve 8-30© 2012 McGraw-Hill Ryerson Limited LO5 Deriving the Supply Curve

Self-Test 8-31© 2012 McGraw-Hill Ryerson Limited Given the data for a competitive firm, what quantities will the firm produce at prices of $25, $35, $45, $55, $65, and $75? LO5 OutputMCAVC 0—— 1$

Self-Test 8-32© 2012 McGraw-Hill Ryerson Limited Given the data for a competitive firm, what quantities will the firm produce at prices of $25, $35, $45, $55, $65, and $75? LO5 OutputMCAVC 0—— 1$ PriceOutput (Q) $

In the short run the size of both the firm and the industry are fixed; In the long run, both are variable 8-33© 2012 McGraw-Hill Ryerson Limited LO6 Industry Demand and Supply

8-34© 2012 McGraw-Hill Ryerson Limited LO6 Industry Demand and Supply

Increasing Cost Industry an industry in which the prices of resources and products both rise as the industry expands Decreasing Cost Industry an industry in which the prices of resources and products both fall as the industry expands Constant Cost Industry an industry in which the prices of resources and products remain unchanged as the industry expands 8-35© 2012 McGraw-Hill Ryerson Limited LO1

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Self-Test 8-37© 2012 McGraw-Hill Ryerson Limited Suppose that demand and supply are as shown below. a)Demand increases by 30 units and new firms enter, causing supply to increase by 30 units. Draw the new curves D2 and S2 and identify equilibrium. What are price and quantity? LO6

Self-Test 8-38© 2012 McGraw-Hill Ryerson Limited b) As a result of the industry expansion, costs of production increase by $6 per unit. (The supply curve shifts up by $6). Label the new supply curve S3. What are price and quantity? Identify equilibrium, and draw in the industry’s long-run supply curve. LO6

Self-Test 8-39© 2012 McGraw-Hill Ryerson Limited a) New equilibrium is at P = $6, Q = 60 b) New equilibrium is at P = $8, Q = 50 LO6

© 2012 McGraw-Hill Ryerson Limited8-40 Concepts of firm, industry, and market The four types of markets The conditions for perfect competition and for a market system Why perfectly competitive firms have a horizontal demand curve Breakeven and shutdown points Chapter 8 Summary

© 2012 McGraw-Hill Ryerson Limited8-41 Maximizing profit using both marginal and total revenue approach Deriving a firm’s supply curve Effects on an industry of changes in demand The long run supply curve in an increasing-cost, decreasing-cost, and constant-cost industry Chapter 8 Summary