CHAPTER 12 Competition.  What is perfect competition?  How are price and output determined in a competitive industry?  Why do firms enter and leave.

CHAPTER 12 Competition

 What is perfect competition?  How are price and output determined in a competitive industry?  Why do firms enter and leave an industry?  How do changes in demand and technology affect an industry?  Why is perfect competition economically efficient?

Perfect Competition  Perfect competition arises when:  There are many firms, each selling an identical product.  There are many buyers.  There are no restrictions on entry into the industry.  Firms in the industry have no advantage over potential new entrants.  Firms and buyers are completely informed about other firms’ prices.

The Firm Has No Control Over the Price It Charges  Since each firm produces a small fraction of total industry output and the products are identical, no firm has any control over price.  Firms are price takers in perfectly competitive markets. A price taker is a firm that cannot influence the price of a good or service.

Elasticity of Industry and Firm Demand  A price taker firm faces a demand curve that is perfectly elastic (horizontal) because the product from firm A is a perfect substitute for the product from firm B.  However, the market demand curve will still slope downward; elasticity will be positive, but not infinite.

Competition in the Real World  In reality, there are no markets that are absolutely perfectly competitive.  However, competition in some industries is so fierce that the model of perfect competition predicts extremely well how firms will behave.  Examples are computers, soft drinks, TVs, DVD players, potato chips, etc.

Economic Profit and Revenue  Total revenue (TR)  Value of a firm’s sales  TR = P  Q  Marginal revenue (MR)  Change in total revenue resulting from a one- unit increase in quantity sold.  MR = TR/ Q  Average revenue (AR)  Total revenue divided by the quantity sold — revenue per unit sold.  AR = TR/Q = PxQ/Q = P  In perfect competition, Price = MR = AR

Economic Profit and Revenue Suppose Cindy sells her sweaters in a perfectly competitive market. What are Cindy’s TR, MR, and AR?

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 9 25 10 25

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 9 25 10 25

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 9 25 225 10 25

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 9 25 225 10 25 250

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 - 9 25 225 10 25 250

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 - 9 25 225 25 10 25 250

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 - 9 25 225 25 10 25 250 25

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 - 25 9 25 225 25 10 25 250 25

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 - 25 9 25 225 25 25 10 25 250 25

Demand, Price, and Revenue in Perfect Competition QuantityPriceMarginalAverage sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q (sweaters perTR = P ´ Q(dollars per (dollars per day)sweater) (dollars) additional sweater)per sweater) 8 25 200 - 25 9 25 225 25 25 10 25 250 25 25

Demand, Price, and Revenue in Perfect Competition Quantity (thousands of sweaters per day) Quantity (sweaters per day) Price (dollars per sweater) Total revenue (dollar per day) 0 9 20 0 10 20 0 9 20 25 50 25225 50 Sweater Industry Cindy’s demand, average revenue, and marginal revenue Cindy’s total revenue

Demand, Price, and Revenue in Perfect Competition Quantity (thousands of sweaters per day) Quantity (sweaters per day) Price (dollars per sweater) Total revenue (dollar per day) 0 9 20 0 10 20 0 9 20 25 50 25225 50 S D Sweater Industry

Demand, Price, and Revenue in Perfect Competition Quantity (thousands of sweaters per day) Quantity (sweaters per day) Price (dollars per sweater) Total revenue (dollar per day) 0 9 20 0 10 20 0 9 20 25 50 25225 50 S D AR= MR Sweater Industry Cindy’s demand, average revenue, and marginal revenue Cindy’s demand curve

Demand, Price, and Revenue in Perfect Competition Quantity (thousands of sweaters per day) Quantity (sweaters per day) Price (dollars per sweater) Total revenue (dollar per day) 0 9 20 0 10 20 0 9 20 25 50 25225 50 S D AR= MR TR a Sweater Industry Cindy’s demand, average revenue, and marginal revenue Cindy’s total revenue Cindy’s demand curve

Economic Profit and Revenue  The firm’s goal is to maximize economic profit.  Total cost is the opportunity cost — including normal profit.

The Firm’s Decisions in Perfect Competition  A firm’s task is to make the maximum economic profit possible, given the constraints it faces.  In order to do so, the firm must make two decisions in the short-run, and two in the long-run.

The Firm’s Decisions in Perfect Competition  Short-run  A time frame in which each firm has a given plant and the number of firms in the industry is fixed  Long run  A time frame in which each firm can change the size of its plant and decide whether to leave or stay in the industry.

The Firm’s Decisions in Perfect Competition  In the short-run, the firm must decide:  Whether to produce or to shut down.  If the decision is to produce, what quantity to produce.  Price is not a decision because firm is a price taker.

The Firm’s Decisions in Perfect Competition  In the long-run, the firm must decide:  Whether to increase of decrease its plant size  Whether to stay in the industry or leave it We will first address the short- run.

Total Revenue, Total Cost, and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0022 12545 25066 37585 4100100 5125114 6150126 7175141 8200160 9225183 10250210 11275245 12300300 13325360

Total Revenue, Total Cost, and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0022-22 12545 25066 37585 4100100 5125114 6150126 7175141 8200160 9225183 10250210 11275245 12300300 13325360

Total Revenue, Total Cost, and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0022-22 12545-20 25066 37585 4100100 5125114 6150126 7175141 8200160 9225183 10250210 11275245 12300300 13325360

Total Revenue, Total Cost, and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0022-22 12545-20 25066-16 37585 4100100 5125114 6150126 7175141 8200160 9225183 10250210 11275245 12300300 13325360

Total Revenue, Total Cost, and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0022-22 12545-20 25066-16 37585-10 4100100 5125114 6150126 7175141 8200160 9225183 10250210 11275245 12300300 13325360

Total Revenue, Total Cost, and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0022-22 12545-20 25066-16 37585-10 41001000 512511411 615012624 717514134 820016040 922518342 1025021040 1127524530 123003000 13325360-35

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) Total revenue & total cost (dollars per day) 0 4 9 12 100 300 183 225 Revenue and Cost

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) Total revenue & total cost (dollars per day) 0 4 9 12 100 300 183 TR 225 Revenue and Cost

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) Total revenue & total cost (dollars per day) 0 4 9 12 100 300 183 TR TC 225 Revenue and Cost

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) Total revenue & total cost (dollars per day) 0 4 9 12 100 300 183 225 TR TC Economic loss Economic profit = TR - TC Revenue and Cost

Total Revenue, Total Cost, and Economic Profit 4 9 12 -20 0 -40 42 20 Quantity (sweaters per day) Profit/ loss Profit/loss (dollars per day) Economic profit/loss

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) 4 9 12 -20 0 -40 42 20 Profit maximizing quantity Profit/ loss Economic profit Economic loss Profit/loss (dollars per day) Economic profit/loss

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) 4 9 12 -20 0 -40 42 20 Profit maximizing quantity Profit/ loss Profit/loss (dollars per day) MR>MC MR<MC MR=MC

Break-even Output  An output at which total cost equals total revenue is called a break-even point.  Even though economic profit is zero at break-even output, the firm still earns a normal profit.  Remember, normal profit is part of total (opportunity) cost.

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) Total revenue & total cost (dollars per day) 0 4 9 12 100 300 183 225 TR TC Breakeven Points

Total Revenue, Total Cost, and Economic Profit Quantity (sweaters per day) 4 9 12 -20 0 -40 42 20 Profit maximizing quantity Profit/loss (dollars per day) Breakeven Point Profit/ loss

Marginal Analysis  Using marginal analysis, a comparison is made between a units marginal revenue and marginal cost.

Marginal Analysis  If MR > MC, the extra revenue from selling one more unit exceeds the extra cost.  The firm should increase output to increase profit  If MR < MC, the extra revenue from selling one more unit is less than the extra cost.  The firm should decrease output to increase profit  If MR = MC economic profit is maximized.

Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q)revenue( dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day)(dollars)sweater)(dollarssweater)(dollars) 717514134 8 20016040 922518342 1025021040 1127524530 - -

Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q)revenue( dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day)(dollars)sweater)(dollarssweater)(dollars) 717514134 8 20016040 922518342 1025021040 1127524530 - - 25

Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q)revenue( dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day)(dollars)sweater)(dollarssweater)(dollars) 717514134 8 20016040 922518342 1025021040 1127524530 - 19 - 25

Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q)revenue( dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day)(dollars)sweater)(dollarssweater)(dollars) 717514134 8 20016040 922518342 1025021040 1127524530 - 19 23 - 25

Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q)revenue( dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day)(dollars)sweater)(dollarssweater)(dollars) 717514134 8 20016040 922518342 1025021040 1127524530 - 19 23 27 - 25

Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q)revenue( dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day)(dollars)sweater)(dollarssweater)(dollars) 717514134 8 20016040 922518342 1025021040 1127524530 - 19 23 27 35 - 25

Profit-Maximizing Output Quantity (sweaters per day) 8 9 10 10 20 30 Marginal revenue & marginal cost (dollars per day) 25

Profit-Maximizing Output Quantity (sweaters per day) 8 9 10 10 20 30 Marginal revenue & marginal cost (dollars per day) MR = AR = P 25

Profit-Maximizing Output Quantity (sweaters per day) 8 9 10 10 20 30 Marginal revenue & marginal cost (dollars per day) MR = AR = P 25 MC

Profit-Maximizing Output Quantity (sweaters per day) 8 9 10 10 20 30 Marginal revenue & marginal cost (dollars per day) MR = AR = P 25 MC Profit- maximization point Loss from 10th sweater Profit from 9th sweater

Economic Profit in the Short Run  Maximizing economic profit does not guarantee that profits will be positive.  Economic profit can be positive, negative or zero.  To calculate total profit, we must subtract total cost from total revenue.

Price, Average Total Cost, and Profit  Price is total revenue per unit, or average revenue (P=AR=TR/Q)  Average total cost is total cost per unit (ATC=TC/Q).  Profit = TR - TC  Profit per unit=(TR-TC)/Q=TR/Q-TC/Q  = (P - ATC)  That means we can calculate total profit as (P - ATC)xQ.

Profits and Losses in the Short-Run  As we indicated, at short-run equilibrium firms may:  Earn a profit  Break even  Incur an economic loss.

Profits and Losses in the Short-Run  If price equals average total cost (P=ATC), a firm breaks even.  If price exceeds average total cost (P>ATC), a firm makes an economic profit.  If price is less than average total cost (P<ATC), a firm incurs an economic loss.

Quantity (millions of chips per year) Price (dollars per chip) 15. 00 20.00 25.00 Three Possible Profit Outcomes in the Short-Run 8 10 30.00 MCATC Possible Outcome One P=ATC

Quantity (millions of chips per year) Price (dollars per chip) 15. 00 20.00 25.00 Three Possible Profit Outcomes in the Short-Run 8 10 30.00 AR = MR = P MCATC Break-even point Possible Outcome One P=ATC Profits=(P-ATC)xQ =(20-20)x8 = 0

Quantity (millions of chips per year) Price (dollars per chip) 15. 00 20.00 25.00 Three Possible Profit Outcomes in the Short-Run 8 10 30.00 MCATC Possible Outcome Two P>ATC

Quantity (millions of chips per year) Price (dollars per chip) 15. 00 20.33 25.00 Three Possible Profit Outcomes in the Short-Run 9 10 30.00 AR = MR = P MCATC Possible Outcome Two P>ATC Profits =(P-ATC)xQ =(25-20.33)x9 =4.67x9=42

Quantity (millions of chips per year) Price (dollars per chip) 15. 00 20.33 25.00 Three Possible Profit Outcomes in the Short-Run 9 10 30.00 AR = MR = P MCATC Possible Outcome Two P>ATC Profits =(P-ATC)xQ =(25-20.33)x9 =4.67x9=42 Economic Profit

Quantity (millions of chips per year) Price (dollars per chip) 15. 00 20.00 25.00 Three Possible Profit Outcomes in the Short-Run 9 10 30.00 MCATC Possible Outcome Three P<ATC

Quantity (millions of chips per year) Price (dollars per chip) 17. 00 20.14 25.00 Three Possible Profit Outcomes in the Short-Run 30.00 MCATC Possible Outcome Three P<ATC AR = MR = P 7 10 Profits =(P-ATC)xQ =(17-20.14)x7 =-22

Quantity (millions of chips per year) Price (dollars per chip) 17. 00 20.14 25.00 Three Possible Profit Outcomes in the Short-Run 30.00 MCATC Possible Outcome Three P<ATC AR = MR = P 7 10 Profits =(P-ATC)xQ =(17-20.14)x7 =-22 Economic Loss

Three Possible Profit Outcomes in the Short-run

The Firm’s Short-Run Supply Curve  Fixed costs must be paid in the short-run.  Variable-costs can be avoided by laying off workers and shutting down.  Firms shut down if price falls below the minimum of average variable cost.

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day)

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) AVC ATC

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) MC AVC ATC

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) MC MR 1 =P 1 =25 AVC

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) MC MR 2 =P 2 =31 AVC

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) MC MR 0 =P 0 =17 AVC s Shutdown point

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) MC = Supply AVC s MR 1 =P 1 =25 MR 2 =P 2 =31 MR 0 =P 0 =17

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) S = MC s AVC

A Firm’s Supply Curve Quantity (sweaters per day) 7 9 10 17 25 31 Marginal revenue & marginal cost (dollars per day) S = MC s

The Firm’s Short-Run Supply Curve  A perfectly competitive firm’s short-run supply curve shows how its profit- maximizing output varies as market price changes.  Since price must equal marginal cost, the marginal cost curve is also the supply curve.  However, only the portion of the marginal cost curve above the minimum average variable cost curve is relevant.

Temporary Plant Shutdown  A firm cannot avoid incurring its fixed costs but it can avoid variable costs.  A firm that shuts down and produces no output incurs a loss equal to its total fixed cost.  A firm’s shutdown point is the level of output and price where the firm is just covering its total variable cost.  In other words, if its losses are bigger than its fixed costs, the firm will shut down.

Production Decisions  When price is below the minimum point of the AVC curve, the firm will shut down and supply zero output.  When price is above the lowest point of the AVC curve, the firm will produce the level of output where price equals marginal cost.  The short-run supply curve is therefore the MC curve above the AVC curve.

Output, Price, and Profit in the Long Run  In short-run equilibrium, a firm might make an economic profit, incur an economic loss, or break even (make a normal profit). Only one of these situations is a long-run equilibrium.  In the long run either the number of firms in an industry changes or firms change the scale of their plants.

Economic Profit and Economic Loss as Signals  If an industry is earning above normal profits (positive economic profits), firms will enter the industry and begin producing output.  This will shift the industry supply curve out, lowering price and profit.

Economic Loss as a Signal  If an industry is earning below normal profits (negative economic profits), some of the weaker firms will leave the industry.  This shifts the industry supply curve in, raising price and profit.

Long-Run Adjustments  Forces in a competitive industry ensure only one of these situations is possible in the long-run.  Competitive industries adjust in two ways:  Entry and exit  Changes in plant size

Entry and Exit  The prospect of persistent profit or loss causes firms to enter or exit an industry.  If firms are making economic profits, other firms enter the industry.  If firms are making economic losses, some of the existing firms exit the industry.

Entry and Exit  This entry and exit of firms influence price, quantity, and economic profit. Let’s investigate the effects of firms entering or exiting an industry.

S1S1 Entry Quantity (thousands of sweaters per day) 6 7 8 9 10 Price (dollars per sweater) D1D1 23 17 20

Entry Quantity (thousands of sweaters per day) 6 7 8 9 10 Price (dollars per sweater) S1S1 S0S0 23 17 20 D1D1

Exit Quantity (thousands of sweaters per day) 6 7 8 9 10 Price (dollars per sweater) D1D1 23 17 20 S2S2

Exit Quantity (thousands of sweaters per day) 6 7 8 9 10 Price (dollars per sweater) S0S0 23 17 20 D1D1 S2S2

Entry and Exit Quantity (thousands of sweaters per day) 6 7 8 9 10 Price (dollars per sweater) S0S0 23 17 20 D1D1 S2S2 S1S1

Entry and Exit Important Points  As new firms enter an industry, the price falls and the economic profit of each existing firm decreases.  As firms leave an industry, the price rises and the economic loss of each remaining firm decreases.

Long-Run Equilibrium  Long-run equilibrium occurs in a competitive industry when firms are earning normal profit and economic profit is zero.  Economic profits draw in firms and cause existing firms to expand.  Economic losses cause firms to leave and cause existing firms to scale back.

Long-Run Equilibrium  So in long-run equilibrium in a competitive industry, firms neither enter nor exit the industry and firms neither expand their scale of operation nor downsize.

Long-Run Equilibrium  In long-run equilibrium, firms will be earning only a normal profit. Economic profits will be zero.  Firms will neither enter nor exit the industry.  In long run equilibrium, P=MC and P=ATC. Thus, P=MC=ATC.  Because MC=ATC, ATC must be at its minimum.

Changing Tastes and Advancing Technology What happens in a competitive industry when a permanent change in demand occurs?

A Decrease in Demand Quantity Price 0 Quantity Price and Cost IndustryFirm

A Decrease in Demand Quantity Price 0 P0P0 Quantity Price and Cost P0P0 q0q0 D0D0 MR 0 S0S0 MC ATC IndustryFirm Q0Q0

A Decrease in Demand Quantity Price 0 P0P0 Quantity Price and Cost P0P0 q0q0 D0D0 MR 0 S0S0 MC ATC IndustryFirm D1D1 P1P1 MR 1 q1q1 Q0Q0 Q1Q1 P1P1

A Decrease in Demand Quantity Price 0 Quantity Price and Cost S0S0 MC ATC IndustryFirm D1D1 P1P1 MR 1 q1q1 Q1Q1 P1P1

A Decrease in Demand Quantity Price 0 P0P0 Quantity Price and Cost P0P0 q0q0 MR 0 S0S0 MC ATC IndustryFirm D1D1 P1P1 MR 1 q1q1 Q1Q1 S1S1 Q2Q2 P1P1

A Decrease in Demand Quantity Price 0 P0P0 Quantity Price and Cost P0P0 q0q0 MR 0 S0S0 MC ATC IndustryFirm D1D1 MR 1 S1S1 Q2Q2

A Decrease in Demand Quantity Price 0 P0P0 Quantity Price and Cost P0P0 q0q0 D0D0 MR 0 S0S0 MC ATC IndustryFirm D1D1 P1P1 MR 1 q1q1 Q0Q0 Q1Q1 S1S1 Q2Q2 Summary P1P1

Changing Tastes and Advancing Technology  Technological change  New technology allows firms to produce at lower costs. This causes their cost curves to shift downward.  Firms adopting the new technology make an economic profit. This draws in new technology firms  Old technology firms disappear, the price falls, and the quantity produced increases.

Changing Tastes and Advancing Technology  A competitive industry is rarely in a long-run equilibrium.  What happens in a competitive industry when there is a permanent increase or decrease in the demand for its product?  What happens in a competitive industry when technological change lowers its production costs?

A Permanent Change in Demand  A permanent decrease in demand will cause the short-run equilibrium price and quantity to fall.  In the long run, firms will leave the industry (because economic profits are negative), raising price enough to restore a normal level of profit.  The difference is the number of firms in the industry.

A Permanent Increase in Demand  The increase in demand causes industry price and profits to rise.  Firms enter the industry, increasing market supply and eventually lowering price to its original level.  However there are now more firms in the industry.

Technological Change  Technological improvements lower average cost of production.  Most technological improvements cannot be implemented without investment in new plant and equipment.  This means it takes time for a technological advance to spread through an industry.

Technological Change and Equilibrium Price  A technological improvement that affects all firms will shift the industry supply curve down and to the right.  Firms now earn economic profits and new firms enter the industry.  This this drives down equilibrium price and raises industry output.

Technological Change and Equilibrium Profit  Implementing a technological improvement causes the marginal cost curve for each firm to shift down and to the right.  Economic profits are not affected in the long run.  The firms that survive in the long run are those that adopted the new technology early.

CHAPTER 12 Competition.  What is perfect competition?  How are price and output determined in a competitive industry?  Why do firms enter and leave.

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CHAPTER 12 Competition.  What is perfect competition?  How are price and output determined in a competitive industry?  Why do firms enter and leave.

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Presentation on theme: "CHAPTER 12 Competition.  What is perfect competition?  How are price and output determined in a competitive industry?  Why do firms enter and leave."— Presentation transcript:

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