2. ECON107 Principles of Microeconomics Week 13 DECEMBER 2013 1 13w/12/2013 Dr. Mazharul Islam Chapter-12

3. Dr. Mazharul Islam 13w/12/2013 12 PERFECT COMPETITION

4. Lesson Objectives  Define perfect competition  How perfect competition arises  Explain how a firm makes its output decision  Explain how price and output are determined in perfect competition 3 Dr. Mazharul Islam 13w/12/2013

5. Perfect Competition  Perfect competition is a market in which  Many firms sell identical products to many buyers (Standardized Product).  There are no restrictions to entry into the industry (Free Entry and Exit).  Established firms have no advantages over new ones (Price Takers).  Sellers and buyers are well informed about prices. 4 Dr. Mazharul Islam 13w/12/2013

6. How Perfect Competition Arises  Perfect competition arises when:  the firm’s minimum efficient scale is small relative to market demand so there is room for many firms in the market.  each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care which firm’s good they buy. 5 Dr. Mazharul Islam 13w/12/2013

7. Perfect Competition A price taker is a firm that cannot influence the price of a good or service.  No single firm can influence the price— it must “take” the equilibrium market price.  Each firm’s output is a perfect substitute for the output of the other firms, so the demand for each firm’s output is perfectly elastic. 6 Dr. Mazharul Islam 13w/12/2013

8. Goals of Perfectly Competitive firm  The goal of each competitive firm is to maximize economic profit, which equals total revenue minus total cost. 7 Dr. Mazharul Islam 13w/12/2013

9. SHORT RUN PROFIT MAXIMIZATION 8 Dr. Mazharul Islam 13w/12/2013 Two Approaches... First: Total-Revenue -Total Cost Approach The Decision Rule: Produce in the short-run if it can realize 1- A profit (or) 2- A loss less than its fixed costs The Decision Process: Should the firm produce ( Whether to enter or exit a market) ? What quantity should be produced? What profit or loss will be realized ( How to produce at minimum cost) ? Second: Marginal-Revenue -Marginal Cost Approach

10. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER 9 Dr. Mazharul Islam 13w/12/2013 $131 131 0 1 2 3 4 5 6 7 8 9 10 $ 0 131 262 393 524 655 786 917 1048 1179 1310 $131 131 Product Price (P) (Average Revenue) Total Revenue (TR) Marginal Revenue (MR) Quantity Demanded (Q) ] ] ] ] ] ] ] ] ] ]

11. 10 Dr. Mazharul Islam 13w/12/2013 TR D = MR 1 2 3 4 5 6 7 8 9 10 1179 1048 917 786 655 524 393 262 131 0 Price and revenue Quantity Demanded (sold)

12. 11 Dr. Mazharul Islam 13w/12/2013 Total Cost 0 1 2 3 4 5 6 7 8 9 10 Total Product Total Fixed Cost Total Variable Cost Total Revenue Profit $ 100 100 $ 0 90 170 240 300 370 450 540 650 780 930 $ 100 190 270 340 400 470 550 640 750 880 1030 Price: $131 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 TOTAL REVENUE-TOTAL COST APPROACH $ 0 131 262 393 524 655 786 917 1048 1179 1310 Can you see the profit maximization?

13. 12 Dr. Mazharul Islam 13w/12/2013 $1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100 0 Total revenue and total cost Total Revenue Total Cost Maximum Economic Profits $299 Break-Even Point (Normal Profit) Break-Even Point (Normal Profit) 1 2 3 4 5 6 7 8 9 10 11 12 13 14

14. 13 Dr. Mazharul Islam 13w/12/2013 Second: Marginal-Revenue -Marginal Cost Approach Profit is maximized by producing the output at which marginal revenue (MR), equals marginal cost (MC). MR = MC Rule

15. 14 Dr. Mazharul Islam 13w/12/2013 Average Total Cost 0 1 2 3 4 5 6 7 8 9 10 Total Product Average Fixed Cost Average Variable Cost Price = Marginal Revenue Total Economic Profit/Loss $100.00 50.00 33.33 25.00 20.00 16.67 14.29 12.50 11.11 10.00 $90.00 85.00 80.00 75.00 74.00 75.00 77.14 81.25 86.67 93.00 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 $ 131 131 Marginal Cost 90 80 70 60 70 80 90 110 130 150 Graphically

16. 15 Dr. Mazharul Islam 13w/12/2013 If MR > MC, economic profit increases if output increases. If MR < MC, economic profit decreases if output increases. If MR = MC, economic profit decreases if output changes in either direction, so economic profit is maximized. $200 150 100 50 0 Cost and Revenue 1 2 3 4 5 6 7 8 9 10 MC MR Economic Profit $131.00 $97.78 AVC ATC

17. 16 Dr. Mazharul Islam 13w/12/2013 Second: Marginal-Revenue -Marginal Cost Approach  A firm’s shutdown point is the point at which it is indifferent between producing and shutting down.  This point is where AVC is at its minimum.  It is also the point at which the MC curve crosses the AVC curve.

18. 17 Dr. Mazharul Islam  Figure shows the shutdown point.  Minimum AVC is $17 a sweater.  If the price is $17, the profit- maximizing output is 7 sweaters a day.  The firm incurs a loss equal to the red rectangle.  If the price of a sweater is between $17 and $20.14, the firm produces the quantity at which marginal cost equals price.  The firm covers all its variable cost and at least part of its fixed cost.  It incurs a loss that is less than TFC.

19. 18 Dr. Mazharul Islam Output, Price, and Profit in the Short Run Market Supply in the Short Run The short-run market supply curve shows the quantity supplied by all firms in the market at each price when each firm’s plant and the number of firms remain the same.

20. 19 Dr. Mazharul Islam Output, Price, and Profit in the Short Run Cost and Revenue, (dollars) MC MR 1 AVC ATC Quantity Supplied MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Do not Produce – Below AVC Break-even (Normal Profit) Point

21. 20 Dr. Mazharul Islam Output, Price, and Profit in the Short Run Cost and Revenue, (dollars) MC MR 1 MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Yields the Short-Run Supply Curve Supply No Production Below AVC

22. 21 Dr. Mazharul Islam  At a price equal to minimum AVC, the shutdown price, some firms will produce the shutdown quantity and others will produces zero.  The market supply curve is perfectly elastic. Short-Run Equilibrium  Short-run market supply and market demand determine the market price and output.  Figure shows a short-run equilibrium.

23. 22 Dr. Mazharul Islam In part (a) price equals average total cost and the firm makes zero economic profit (breaks even). In part (b), price exceeds average total cost and the firm makes a positive economic profit. In part (c) price is less than average total cost and the firm incurs an economic loss—economic profit is negative.

24. Now it’s over for today. Do you have any question? 23 Dr. Mazharul Islam 5w/9/2013