1. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Understanding Economics 5th edition by Mark Lovewell

2. Chapter 5 Perfect Competition Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

3. Learning Objectives After this chapter you will be able to: 1. distinguish the four market structures, and the main differences among them 2. understand the profit-maximizing rule and how perfect competitors use it in the short run 3. identify how perfect competitive markets adjust in the long run, and the benefits they provide to consumers Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

4. Market Structures There are four main market structures: perfect competition monopolistic competition oligopoly monopoly Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

5. Perfect Competition Perfectly competitive markets have three main features: many buyers and sellers a standard product easy entry and exit Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

6. Monopolistic Competition Monopolistically competitive markets have three main features: many buyers and sellers slightly different products easy entry and exit Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

7. Oligopoly and Monopoly In an oligopoly a few businesses (protected by entry barriers) provide standard or similar products. In a monopoly a single business (protected by entry barriers) provides a product with no close substitutes. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

8. Entry Barriers There are six main entry barriers in oligopolies and monopolies: increasing returns to scale market experience restricted ownership of resources legal obstacles (such as patents) market abuses (such as predatory pricing) advertising (which is most common in oligopolies) Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

9. Market Power Market power: is a business’s ability to affect the price it charges varies with market structure, such that monopolists have the most and perfect competitors have the least Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

10. Attributes of Market Structures Figure 5.1, Page 119 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Numbers of Businesses Type of Product Entry and Exit of New Business Market Power Example Perfect Competition very many standard very easy none farming Monopolistic Competition many differentiated fairly easy some restaurants Oligopoly few standard or differentiated difficult some automobile manufacturing Monopoly one not applicable very difficult great public utilities

11. Perfect Competitor’s Demand (a) A perfect competitor has a demand curve different from the market demand curve. The business’s demand curve is horizontal at the prevailing market price. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

12. Perfect Competitor’s Demand (b) Figure 5.2, page 121 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Market Demand and Supply Curves for T-Shirts 0 27 000 6 Quantity of T-Shirts per Day Price ($ per T-Shirt) SmSm DmDm Pure ‘n’ Simple T-Shirts’ Demand Curve 0 6 Quantity of T-Shirts per Day Price ($ per T-Shirt) DbDb

13. Average and Marginal Revenue Total revenue is used to find two other revenue concepts: average revenue (total revenue divided by output) marginal revenue (change in total revenue divided by change in output) Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

14. Revenue Conditions for a Perfect Competitor Average revenue equals price, so that a perfect competitor’s average revenue curve is its horizontal demand curve. A perfect competitor’s average revenue (price) is constant so that marginal revenue and average revenue are always equal. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

15. Revenues for a Perfect Competitor Figure 5.3, page 122 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. $-- 6 Revenue Curves for Pure ‘n’ Simple T-Shirts 0 6 Quantity of T-Shirts per Day $ per T-Shirt D b = AR = MR $ 0 80 200 250 270 280 $ 0 480 1200 1500 1620 1680 480/80 = $6 720/120 = 6 300/50 = 6 120/20 = 6 60/10 = 6 480/80 = $6 1200/200 = 6 1500/250 = 6 1620/270 = 6 1680/280 = 6 Price (P) ($ per T-shirt) Revenue Schedules for Pure ‘n’ Simple T-Shirts Quantity (q) (T-Shirts per day) Total Revenue (TR) (P x q) Marginal Revenue (MR) (ΔTR/Δq) Average Revenue (AR) (TR x q)

16. The Profit-Maximizing Rule The profit-maximizing rule states that profit is maximized when marginal revenue equals marginal cost. This means: output should be increased if marginal revenue exceeds marginal cost output should be decreased if marginal cost exceeds marginal revenue Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

17. Profit Maximization for a Perfect Competitor Figure 5.4, page 124 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 0 80 200 250 270 280 Total Product (q) Price (P) (=AR) Marginal Revenue (MR) Marginal Cost (MC) (ΔTC/Δq) Average Variable Cost (AVC) (VC/q) Profit Maximization Table for Pure ‘n’ Simple T-Shirts Average Cost (AC) (TC/q) Total Revenue (TR) Total Cost (TC) Total Profit (TR - TC) $6 6 $6 6 6 6 6 $1.75 1.33 2.50 5.50 10.50 $1.75 1.50 1.70 1.98 2.29 $12.06 5.63 5.00 5.04 5.24 $ 0 480 1200 1500 1620 1680 $ 825 965 1125 1250 1360 1465 $-825 -485 75 250 260 215 5.04 Profit Maximization Graph for Pure ‘n’ Simple T-Shirts 0 Quantity of T-Shirts per Day $ per T-Shirt 6.00 270 MC AC AVC D b = MR = AR a b Profit = $260

18. The Breakeven and Shutdown Points The breakeven point is where a business breaks even while maximizing profit. For a perfect competitor this occurs where price equals minimum average cost. The shutdown point is the lowest price at which a business will choose to operate in the short run. It occurs where price equals minimum average variable cost. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

19. A Perfect Competitor’s Supply Curve A perfect competitor’s supply curve is its marginal cost curve above the shutdown point. The market supply curve can be found by horizontally adding the supply curves for all the businesses in the industry. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

20. Supply Curve for a Perfect Competitor Figure 5.5, page 126 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Supply Curve for Pure ‘n’ Simple T-Shirts 0 5.00 Quantity of T-Shirts per Day $ per T-Shirt 6.00 270 1.40 1.50 200250 a b c d MC(=S b ) MR 1 AC MR 2 AVC Supply Schedule for Pure ‘n’ Simple T-Shirts Price (P) ($ per T-Shirt Quantity Supplied (q) (T-Shirts per day) $6.00 5.00 1.50 1.40 270 250 200 0

21. Supply Curves for a Perfectly Competitive Business and Market Figure 5.6, page 127 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Supply Curve for Pure ‘n’ Simply T-Shirts 0 5.00 Quantity of T-Shirts per Day Price ($ per T-Shirt) 6.00 270 250 200 1.50 0 Supply Curve for T-Shirt Market 5.00 Quantity of T-Shirts per Day Price ($ per T-Shirt) 6.00 27 000 25 00020 000 1.50 $6.00 5.00 1.50 270 250 200 27 000 25 000 20 000 Business and Market Supply Schedules for T-Shirts Price (P) ($ per T-Shirt) Quantity Supplied (q) (S b ) (q) (S m ) (T-Shirts per day) SbSb SmSm

22. Perfect Competition in the Long Run Entry and exit by businesses in the long run drives a perfectly competitive market to the breakeven point. Businesses enter markets where economic profits are made so that supply shifts right and price falls. Businesses leave markets where economic losses are made so that supply shifts left and price rises. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

23. Long-Run Equilibrium for a Perfectly Competitive Business Figure 5.7, page 129 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. T-Shirt Market 0 Quantity of T-Shirts per Day $ per T-Shirt 30 000 27 00025 000 5 6 Pure ‘n’ Simply T-Shirts 0 5 Quantity of T-Shirts per Day $ per T-Shirt 6 270250 MR MC AC a b D0D0 S0S0 S1S1 D1D1 d e c

24. The Benefits of Perfect Competition Perfectly competitive markets in long-run equilibrium meet two conditions that benefit consumers: minimum-cost pricing (price = minimum average cost) marginal-cost pricing (price = marginal cost) Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

25. How Resource Markets Operate The demand for resources is based on the demand for the products that these resources are used to produce. According to marginal productivity theory, businesses use resources based on how much extra profit each of these resources provides. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

26. The Demand for Resources Three factors are important in determining the demand for a resource: a resource’s marginal cost a resource’s marginal product the marginal revenue of new units of output Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

27. A Product and Resource Price- Taker If a business is a price-taker in its product and resource markets: the resource’s marginal cost is constant the resource’s marginal product is variable the marginal revenue of new units of output is constant Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

28. The Profit-Maximizing Employment Rule The profit-maximizing employment rule states that profits are maximized when marginal revenue product equals marginal resource cost. Marginal revenue product is the change in total revenue when employing a new unit of a resource. Marginal resource cost is the change in total cost when employing a new unit of a resource. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

29. Labour Demand and Supply for a Product and Resource Price-Taker Figure A, Page 135 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 0 1 2 3 4 5 MRP = D b a Labour Demand and Supply Schedules for a Strawberry Farm Total Product (P) (q) (kilograms) Labour (L) (no. of workers) Marginal Product (MP) (Δq/ΔL) (kilograms) Output Price (P) ($ per kilogram) Total Revenue (TR) (P x q) Marginal Revenue Product (MRP = ΔTR) Marginal Resource Cost (MRC = W) ($ per hour) 0 10 18 24 28 30 10 8 6 4 2 $2 2 2 2 2 2 $ 0 20 36 48 56 60 $20(a) 16(b) 12(c) 8(e) 4(f) $10 10 > (d) 3 0 14 No. of Workers Labour Demand and Supply Curves for a Strawberry Farm Wage ($ per hour) 4 8 16 20 2 12 5 MRC = S b b c d e f

30. Market Demand and Supply In a competitive labour market: the market demand curve is found by horizontally summing the labour demand curves for all businesses in the industry the market supply curve shows the total number of workers offering their services in this industry at each wage Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

31. Demand and Supply in a Competitive Labour Market Figure B, Page 137 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. $18 14 10 6 2 SMSM Labour Demand and Supply Schedules for Strawberry Farm Workers Labour Demanded (D M ) Wage (W) ($ per hour) Labour Supplied (S M ) (no. of workers) (market) (no. of workers) (farm) (no. of workers) (market) 1 2 3 4 5 1000 2000 3000 4000 5000 4000 3000 2000 1000 DMDM e 3000 10 0 1000 2000 4000 No. of Workers Labour Demand and Supply Curves for Strawberry Farm Workers Wage ($ per hour) 2 6 14 18 5000

32. Demand for Other Resources Marginal productivity theory is not always applicable to other resources. The theory can be employed for labour and for natural resources, because these resources are measured in standardized units. It is harder to calculate marginal revenue product for capital goods, because one investment project differs from another. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

33. Can Capitalism Survive? Joseph Schumpeter: believed that entrepreneurs are the driving force of economic progress in capitalism predicted that capitalism was doomed because of the growing dominance of government bureaucracy antagonistic to capitalism Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

34. Resource Demand (Online Learning Center) A Product Price-Maker/ Resource Price-Taker (a) If a business is a price-maker in its product market and a price-taker in its resource market, then: the resource’s marginal cost is constant the resource’s marginal product varies the marginal revenue of the new units of output falls as quantity rises Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

35. Resource Demand (Online Learning Centre) A Product Price-Maker/ Resource Price-Taker (b) Just as in the case of a business that is a price-taker in its product market, the profit-maximizing rule also applies in this case of a product price-maker. In other words, the business should use a resource up to the point where its marginal revenue product and its marginal revenue cost intersect. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

36. Resource Demand (Online Learning Centre) Labour Demand and Supply for a Product Price- Maker/Resource Price Taker Figure A Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 0123401234 Labour Demand and Supply Schedules for Nirvana Cushions Total Product (P) (q) (no. of cushions) Labour (L) (no. of workers) Marginal Product (MP) (Δq/ΔL) (no. of cushions) Output Price (P) Total Revenue (TR) (P x q) Marginal Revenue Product (MRP = ΔTR/ ΔL) Marginal Resource Cost (MRC = W) ($ per hour) 0 4 7 9 10 43214321 $10 8 6 5 4 $ 0 32 42 45 40 $32(g) 10(h) 3(j) -5(k) $7 7 > (i) MRP = D b g MRC = S b 7 2 0 1 3 4 No. of Workers Labour Demand and Supply Curves for Nirvana Cushions Wage ($ per hour) 3 32 10 5 -5 h i j k

37. Resource Demand (Online Learning Centre) Market Demand and Supply If the resource market this business is operating in is competitive, the degree of competition in the product does not affect how market demand in the resource market is determined. As before (as shown in the text appendix), the resource demand curves of all businesses are combined to find the market demand curve. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

38. Resource Demand (Online Learning Centre) Changes in Resource Demand (a) There are three main resource demand factors: product prices, resource prices, and technological change. Resource demand is affected by changes in product prices. For example, a rise in a product price causes the MRP for relevant resources to rise, shifting demand for these resources to the right. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

39. Resource Demand (Online Learning Centre) Changes in Resource Demand (b) To identify the effect of other resources prices, we must distinguish two types of resource combinations. Complementary resources are used together (e.g. steam shovels and steam-shovel operators). The price for one of these resources and the demand for the other have an inverse relationship. For example, a drop in the price of steam shovels increases the demand for steam shovel operators. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

40. Resource Demand (Online Learning Centre) Changes in Resource Demand (c) Substitute resource are used in place of one another (e.g. steam shovels and manual labour). The price for one of these resources and the demand for the other have a direct relationship. For example, a drop in the price of steam shovels decreases the demand for manual labour. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

41. Resource Demand (Online Learning Centre) Changes in Resource Demand (d) Technological innovation has two possible effects. If a new or more productive type of machine is introduced, for example, complementary resources will increase in demand, while demand for substitute resources will decrease. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

42. The Ethics of Exchange (a) (Online Learning Centre) The ancient philosopher Aristotle: stated that trade should be based on an ‘equality of proportion’ between the two items being exchanged was the first to point out the potential injustices caused by monopoly power Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

43. The Ethics of Exchange (b) (Online Learning Centre) Aristotle distinguished two types of value: Use value relates to a good’s intrinsic characteristics. Exchange value relates to how much a good can fetch in return for other goods. Aristotle saw these values as distinct, based on the so- called paradox of value, whereby some rare goods such as gold are worth more than useful goods such as iron. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

44. The Ethics of Exchange (c) (Online Learning Centre) According to Aristotle and his followers (both historical and present-day), a overemphasis on the exchange values of products diminishes our ability to recognize real worth. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

45. Chapter 5 The End Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.