1. Chapter 9: Competitive Markets
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2. Chapter Outline/Learning Objectives
Section
Learning Objectives
After studying this chapter, you will be able to
9.1 Market Structure and Firm Behaviour
state the difference between competitive behaviour and a competitive market.
9.2 The Theory of Perfect Competition
list the four key assumptions of the theory of perfect competition.
9.3 Short-Run Decisions
derive a competitive firm's supply curve.
determine whether competitive firms are making profits or losses in the short run.
9.4 Long-Run Decisions
explain the role played by profits, entry, and exit in determining a competitive industry's long-run equilibrium.
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Chapter 9, Slide

3. Industry Market Perfect Competition a group of producers
LO1
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
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4. LO1
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5. 9.1 Market Structure and Firm Behaviour
Competitive Market Structure
The competitiveness of the market—the influence that individual firms have on market prices.
The less power an individual firm has to influence the market price, the more competitive is that market's structure.
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6. Competitive Behaviour
The term competitive behaviour refers to the degree to which individual firms actively vie with one another for business.
Examples:
MasterCard and Visa engage in competitive behaviour but their market is not competitive.
Two wheat farmers do not engage in competitive behaviour but they both exist in a very competitive market.
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7. The Significance of Market Structure
The demand curve faced by an individual firm may be different from the demand curve for the industry as a whole. Market structure plays a central role in determining the efficiency of the market. In this chapter we focus on competitive market structures.
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8. 9.2 The Theory of Perfect Competition
The Assumptions of Perfect Competition
All firms sell a homogeneous product.
Customers know the product and each firm's price.
Each firm reaches its minimum LRAC at a level of output that is small relative to the industry's total output
Firms are free to exit and enter the industry.
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9. The Demand Curve for a Perfectly Competitive Firm
Fig The Demand Curve for a Competitive Industry and for One Firm in the Industry
Each firm in a perfectly competitive market faces a horizontal demand curve—even though the industry demand curve is downward sloping.
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10. Why Small Firms Are Price Takers
This does not mean the firm could actually sell an infinite amount at the market price.  "Normal" variations in the firm's level of output have a negligible effect on total industry output.
APPLYING ECONOMIC CONCEPTS 9-1
Why Small Firms Are Price Takers
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11. Total, Average, and Marginal Revenue
Total revenue (TR): TR = p x q Average revenue (AR): AR = (p x q)/q = p Marginal revenue (MR): MR =  TR/ q = p Note: For a perfectly competitive firm, AR = MR = p
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12. Total Revenue Average Revenue Marginal Revenue
LO3
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
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13. Fig. 9-2 Revenues for a Price-Taking Firm
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14. 9.3 Short-Run Decisions The firm's objective is to maximize profits:
Profits = TR – TC
As the firm changes its level of output:
Firm's costs vary
Firm's total, average, and marginal revenue vary
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15. Should the Firm Produce at All?
If the firm produces nothing
 must pay its fixed costs (TFC)
If the firm decides to produce
must also pay the variable cost of production (TVC)
receives revenue from sales (TR)
A firm should produce only if at some level of output, TR exceeds TVC.
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16. Should the Firm Produce at All?
A firm should produce only if at some level of output, price exceeds AVC. At the shut-down price the firm can just cover its average variable cost, and so is indifferent between producing and not producing.
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17. Fig. 9-3 Shut-Down Price for a Competitive Firm
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18. How Much Should the Firm Produce?
Suppose p > AVC  firm does not shut down. To maximize profits, the firm chooses the output where MR = MC. But for a competitive firm, MR = p:  The rule: choose output where p = MC.
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19. Fig. 9-4(i) Profit Maximization for a Competitive Firm
The market determines the equilibrium price. The firm then picks the quantity of the output that maximizes its own profits. When the firm has reached q*, it has no incentive to change its output.
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20. Fig. 9-4(ii) Profit Maximization for a Competitive Firm
The profit maximizing level of output is the point at which price (marginal revenue) equals marginal cost. When the firm has reached q*, it has no incentive to change its output.
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21. Self-Test
LO3
Given the data for Marshall’s Meat Ltd., calculate total profits at each output. What are break-even and profit-maximizing outputs? Q P TR TC Tп 50 40 1
135 2
180 3
220 4
230 5
250 6
280 7
350 8
450
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22. Self-Test
LO4
The accompanying graph shows the costs for a perfectly competitive firm.
a) What is the break-even price?
b) What is the shutdown price?
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23. Short-Run Supply Curves
Fig. 9-5 The Derivation of the Supply Curve for a Competitive Firm
A competitive firm's supply curve is given by its marginal cost curve (at prices above AVC).
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24. Fig. 9-6 The Derivation of a Competitive Industry's Supply Curve
A competitive industry's supply curve is the horizontal summation of the individual MC curves (above minimum of AVC curves).
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25. Self-Test
LO5
Given the data for a competitive firm, what quantities will the firm produce at prices of $25, $35, $45, $55, $65, and $75?
Output MC
AVC — 1
$40 2 20 30 3 4 40
32.5 5 50 36 6 60 7 70
44.3 8 80 48
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26. Short-Run Equilibrium in a Competitive Market
When an industry is in short-run equilibrium, two things are true:
market price is such that the market clears
each firm is maximizing its profits at this price
But how large are each firm's profits in this SR equilibrium?
There are three possibilities:
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27. Case 1: Zero Economic Profits
Fig. 9-8(ii) Alternative Short-Run Profits of a Competitive Firm
The typical firm is just covering its costs, p = ATC. There is zero economic profit.
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28. Case 2: Positive Economic Profits
Fig. 9-8(iii) Alternative Short-Run Profits of a Competitive Firm
Typical firm maximizes profit at q*. Since p > ATC, the firm makes positive economic profits equal to the blue area. Positive profits means that this firm is earning more than it could in its next best alternative venture.
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29. Case 3: Negative Economic Profits (Losses)
Fig. 9-8(i) Alternative Short-Run Profits of a Competitive Firm
The typical firm maximizes its profits by producing at q*. But if p < ATC, the firm suffers losses equal to the red shaded area.
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30. The Parable of the Seaside Inn
MyEconLab
A firm that is maximizing its profit but still making losses is actually minimizing its losses. To see a detailed numerical example of a firm in such a situation, look for An Example of Loss Minimization as Profit Maximization in the Additional Topics section of this book's MyEconLab.
APPLYING ECONOMIC CONCEPTS 9-2
The Parable of the Seaside Inn
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31. 9.4 Long-Run Decisions Entry and Exit
If existing firms have positive economic profits, new firms have an incentive to enter the industry.
If existing firms have zero profits, there are no incentives for new firms to enter, and no incentives for existing firms to exit.
If existing firms have economic losses, there is an incentive for existing firms to exit the industry.
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32. Fig. 9-9(i) The Effect of New Entrants Attracted by Positive Profits
Example: suppose there are positive profits at initial SR equilibrium:
Positive profits attract new firms.
Entry leads to an increase in supply and a decline in price.
Positive profits are eroded.
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33. Fig. 9-10 The Effect of Exit Caused by Losses
How about negative profits, and exit?
Fig The Effect of Exit Caused by Losses
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34. Long-Run Equilibrium
The LR industry equilibrium occurs when there is no longer any incentive for entry or exit (or expansion).
In long-run equilibrium, all existing firms
must be maximizing their profits.
are earning zero economic profits.
are not able to increase their profits by changing the size of their production facilities.
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35. Fig. 9-11 Short-Run Versus Long-Run Profit Maximization for a Competitive Firm
In LR equilibrium, competitive firms produce at the minimum point on their LRAC curves. At q0, the firm is maximizing short-run profits but not its long-run profits.
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36. Fig. 9-12 A Typical Competitive Firm When the Industry is in Long-Run Equilibrium
Minimum Efficient Scale (MES)
In LR competitive equilibrium, each firm's average cost of production is the lowest attainable, given the limits of known technology and factor prices.
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37. Consider a competitive industry that is in long-run equilibrium
Consider a competitive industry that is in long-run equilibrium. Now suppose that the market demand for the industry's product increases. The price will rise, and profits will rise. Entry will then occur, and price will eventually fall. But what will the new long-run equilibrium look like?
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38. MyEconLab www.myeconlab.com
Demand shocks in competitive industries naturally lead to price changes. As prices change, firms' profits rise or fall, and these adjustments cause entry to or exit from the industry. After a new long-run equilibrium is reached, will the market price be at its initial level? The answer depends on the nature of costs within the industry. For more details, look for The Long-Run Industry Supply Curve in the Additional Topics section of this book's MyEconLab.
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39. Changes in Technology
Suppose technological development reduces the costs for newly built plants. New plants will earn economic profits, expand industry output and drive down price. The price will fall until it is equal to the SRATC of the new plants. Old plants may continue, but will earn losses. They will eventually exit.
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40. Fig. 9-13 Plants of Different Vintages in an Industry with Competitive Technological Progress
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41. Declining Industries
What happens when a competitive industry in LR equilibrium experiences a continual decrease in demand? The efficient response is to continue operating with existing equipment as long as variable costs of production can be covered. As demand shrinks, so will capacity. Antiquated equipment in a declining industry is often the effect rather than the cause of the industry's decline.
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Chapter 9, Slide