1 Perfect Competition These slides supplement the textbook, but should not replace reading the textbook

2 What is market structure? Important features of a market, such as the number of firms, product uniformity, ease of entry, and forms of competition

3 What are the four types of Markets?  Perfect Competition  Monopolistic Competition  Oligopoly  Monopoly

4 What is a perfectly competitive market?  homogeneous product  many buyers and sellers  no one has much market power  easy entry & easy exit  can sell all bring to market

5 What is a price taker? A firm that faces a given market price and whose actions have no effect on that market price

6 Why is a firm that is part of a perfectly competitive market a price taker? Because if the firm charges higher than the market price it will not sell even one unit

7 Price per unit Quantity per period Market Equilibrium in Perfect Competition D S 0 Exhibit 1a Surplus Shortage

8 The Firm’s Demand Curve in Perfect Competition Market quantity P S D Individual quantity P d 8

9 How does the firm maximize profit? By finding the rate of output that makes total revenue minus total cost as large as possible

10 7 Maximum economic profit = $12 12 TR TC $ Total dollars Quantity per period Short-Run Profit Maximization Panel A: TR minus TC Exhibit 3a

11 What is marginal revenue? The change in total revenue resulting from a one-unit change in sales

12 What is marginal cost? The change in total cost resulting from a one-unit change in sales

13 At what point are profits maximized? At the level of output where MR = MC, or the last unit of output where MR > MC

14 Q MR TR TC MC ATC Profit Exhibit 2 Maximizing Profits in the Short-Run

15 Why does MR = P in Perfect Competition? Because no matter how many units are brought to market, the firm can sell all of them at the market price

16 What is average revenue? Total revenue divided by output TR / Q

17 Why does AR=P in all markets? Because each unit is sold for the same price at one point in time

18 Total dollars Quantity per period Short-Run Profit Maximization Panel B: MR equals MC 12 0 $5 $4 Profit d = MR = AR ATC MC e a Exhibit 3b

19 At what point are losses minimized? At the level of output where MR = MC, or the last unit of output where MR > MC

20 Q MR TR TC MC ATC Loss Exhibit 4 Minimizing Losses in the Short-Run

21 What will a firm do if average variable cost exceeds price at every level of production? Shut down

22 $ Total dollars Quantity per period Minimizing Short-Run Losses Minimum economic loss = $10 TR TC Panel A: TC and TR Exhibit 5a

23 $ Dollars per unit Quantity per period Minimizing Short-Run Losses MC AVC ATC d = MR = AR Panel B: MC equals MR Exhibit 5b Loss

24 What is the firm’s short-run supply curve? A curve that indicates the quantity a firm supplies at each price in the short run

25 Dollars per unit Quantity per period Summary of Short- Run Output Decisions p1p1 p2p2 p3p3 p4p4 p5p5 q2q2 q3q3 q4q4 q5q5 MC ATC AVC Shutdown point Break-even point d1d1 d2d2 d3d3 d4d4 d5d5 Exhibit 5

26 What is the firm’s short run supply curve? That portion of its MC curve which lies above its AVC curve

27 Total dollars Quantity per period Relationship between Short-Run Profit Maximization and Market Equilibrium Panel A: Firm $5 4 Profit d=MR ATC MC = s Exhibit 8a AVC

28 What is the industry’s short-run supply curve? A curve that indicates the quantity all firms in an industry supply at each price in the short run

29 Aggregating Individual Supply to Form Market Supply Panel A: Firm A Price per unit Quantity per period p'p' p SASA Exhibit 7a

30 Aggregating Individual Supply to Form Market Supply Panel B: Firm B Price per unit Quantity per period p'p' p SBSB Exhibit 7b

31 Aggregating Individual Supply to Form Market Supply Panel C: Firm C Price per unit Quantity per period p'p' p SCSC Exhibit 7c

32 Aggregating Individual Supply to Form Market Supply Panel D: Industry, or market supply Price per unit Quantity per period p'p' p 3060 S A + S B + S C = S 0 Exhibit 7d

33 Price per unit Quantity per period Relationship between Short-Run Profit Maximization and Market Equilibrium Panel B: Industry, or market 12,000 0 $5 D  MC = S Exhibit 8b

34 What is economic profit in the long run? Zero

35 Dollars per unit Quantity per period Long-Run Equilibrium for the Firm q 0 p d ATC MC LRAC e Exhibit 9a

36 Price per unit Quantity per period Long-Run Equilibrium for the Industry Q 0 p D S Exhibit 9b

37 What is the long-run industry supply curve? A curve that shows the relationship between price and quantity supplied once firms fully adjust to any change in market demand

38 What is an increasing-cost industry? An industry that faces higher per-unit production costs as industry output expands in the long run

39 Upward sloping What is the shape of the long-run industry supply curve in an increasing cost industry?

40 What is production efficiency? The condition that exists when output is produced with the least-cost combination of inputs, given the state of technology

41 What is allocative efficiency? The condition that exists when firms produce the output that is most preferred by consumers

42 What is the the marginal cost of each good equal to? The marginal benefit consumers derive from that good

43 What is consumer surplus? The difference between the maximum amount that a consumer is willing to pay for a given quantity of a good and what the consumer actually pays

44 What is producer surplus? The amount by which total revenue from production exceeds total variable cost

45 Consumer Surplus and Producer Surplus for a Competitive Market in the Short Run Dollars per unit Quantity per period 5 $ ,00020,00012,000 6 e m S D Consumer surplus Producer surplus Exhibit 14

46 END

47 Appendix

48 What is a constant-cost industry? An industry that can expand or contract without affecting the long-run per- unit cost of production

49 What is the shape of the long-run industry supply curve? horizontal

50 Dollars per unit Quantity per period q 0 p d ATC MC LRAC d' Profit q' p' Panel A: the Firm Exhibit 10a Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry

51 Dollars per unit Quantity per period Long-Run Adjustment to a Decrease in Demand in a Constant Cost Industry for the Firm q 0 p d ATC MC LRAC e p'' q'' d'' Loss Exhibit 11a

52 Dollars per unit Quantity per period Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry QbQb 0 p QcQc p' QaQa S*S* S'S' S D'D' D a b c Exhibit 10b

53 Dollars per unit Quantity per period QfQf 0 p'' QaQa p QgQg S*S* S S'' D D'' g a f Exhibit 11b Long-Run Adjustment to a Decrease in Demand in a Constant Cost Industry

54 Price per unit Quantity per period QbQb 0 papa pcpc pbpb QcQc QaQa S*S* S'S' S D D'D' a b c Exhibit 12b Long-Run Adjustment to a Increase in Demand in an Increasing Cost Industry

55 Dollars per unit Quantity per period qbqb 0 papa dada ATC MC' a pcpc q dcdc c pbpb MC ATC' dbdb b Exhibit 12a Long-Run Adjustment for the firm to an Increase in Demand in an Increasing Cost Industry

56 What is a decreasing-cost industry? The rare case in which an industry faces lower per-unit production costs as industry output expands in the long run

57 Downward sloping What is the shape of the long-run industry supply curve in a decreasing cost industry?

58 Dollars per unit Quantity per period A Decreasing-Cost Industry Adjusts to an Increase in Demand 0 papa pcpc QcQc QaQa S*S* S'S' S D D'D' a b c Exhibit 13