ECON 202: Principles
of Microeconomics
Chapter 11
Firms in Perfectly Competitive
Markets
Firms in Perfectly Competitive Markets
1.
2.
3.
4.
5.
6.
7.
Market Structures.
Perfectly Competitive Markets.
Maximizing Profit in a Perfectly Competitive Market.
Profit and Loss on the Cost Curve.
Deciding Whether to Produce or to Shut Down in the
Short Run.
Entry and Exit of Firms in the Long Run.
Perfect Competition and Efficiency.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
2
1. Four Market Structures
CHARACTERISTIC
PERFECT
COMPETITION
MONOPOLISTIC
COMPETITION
OLIGOPOLY
MONOPOLY
Number of firms
Many
Many
Few
One
Type of product
Identical
Differentiated
Identical or
differentiated
Unique
Ease of entry
High
High
Low
Entry blocked
Wheat
Selling DVDs
First-class mail
delivery
Apples
Restaurants
Manufacturing
computers
Manufacturing
automobiles
Examples of
industries
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
Tap water
3
2. Perfectly Competitive Market
„
Conditions for perfect competitive market:
Many buyers and sellers, small relative to the market.
Products are identical.
No barriers to new firms entering the market.
„
„
Prices are determined by the interaction of aggregate
demand and aggregate supply.
Firms are so small that cannot affect the price in the
market.
If raise prices, consumers switch to another firm.
Price takers.
Example: wheat farmers.
„
Firms face perfectly elastic demand.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
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2. Perfectly Competitive Market
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
5
3. Maximizing Profit in a Perfectly
Competitive Market
„
„
Profit = Total Revenue – Total Cost
Firms maximize profits by producing the quantity of
output where the difference between total revenue and
total cost is as large as possible.
QUANTITY
(BUSHELS)
(Q)
0
1
2
3
4
5
6
7
8
9
10
ECON 202: Princ. of Microeconomics
TOTAL
REVENUE
(TR)
TOTAL
COSTS
(TC)
PROFIT
(TR-TC)
$0.00
4.00
8.00
12.00
16.00
20.00
24.00
28.00
32.00
36.00
40.00
$1.00
4.00
6.00
7.50
9.50
12.00
15.00
19.50
25.50
32.50
40.50
–$1.00
0.00
2.00
4.50
6.50
8.00
9.00
8.50
6.50
3.50
–0.50
Firms in Perfectly Competitive Markets
6
3. Maximizing Profit in a PCM
„
Marginalist approach:
Starting from zero, to produce one more unit only if additional
revenue is higher than additional cost.
Marginal revenue: additional revenue from last unit sold.
Marginal cost: additional cost from last unit produced.
QUANTITY
(BUSHELS)
(Q)
TOTAL
REVENUE
(TR)
TOTAL
COSTS
(TC)
PROFIT
(TR-TC)
0
1
2
3
4
5
6
7
8
9
$0.00
4.00
8.00
12.00
16.00
20.00
24.00
28.00
32.00
36.00
$1.00
4.00
6.00
7.50
9.50
12.00
15.00
19.50
25.50
32.50
–$1.00
0.00
2.00
4.50
6.50
8.00
9.00
8.50
6.50
3.50
ECON 202: Princ. of Microeconomics
MARGINAL
REVENUE
(MR)
MARGINAL
COST
(MC)
—
$4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
—
$3.00
2.00
1.50
2.00
2.50
3.00
4.50
6.00
7.00
Firms in Perfectly Competitive Markets
7
3. Maximizing Profit in a PCM
„
For firms in perfectly competitive markets, marginal
revenue curve is the same as the demand curve.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
8
3. Maximizing Profit in a PCM
„
In order to maximize profits is equivalent:
To produce where difference between total revenue and total
cost is the greatest.
To produce where marginal revenue is equal to marginal
cost.
„
„
In the case of firms in perfectly competitive markets,
marginal revenue is equal to the price in the market.
Condition for maximizing profit:
Price = Marginal Revenue
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
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4. Profit and Loss on the Cost Curve
„
Remember that:
Total Revenue = Price x Quantity
Total Cost = Average Total Cost x Quantity
Price and cost
(dollars per
bushel)
Marginal
Cost
Average
Total Cost
P
Profit
Total Revenue
Total Cost
Q
Quantity
Profit Maximizing
level of output
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
10
4. Profit and Loss on the Cost Curve
„
Then, by comparing Price and ATC we can say:
P > ATC, firm is making profit.
P = ATC, firm is breaking even.
P < ATC, firm is experiencing losses.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
11
5. Deciding Whether to Produce or to Shut
Down in the Short Run
„
„
„
If the firm incurs in losses, should the firm stop
production or continue operating?
In the short-run, firms can not leave the market because
an input is fixed.
The decision will depend on its fixed cost.
If firm stops production, it will have to pay fixed costs anyway.
If by continue the production, the firm losses less than the fixed
cost, the firm will decide to continue operating.
„
„
Both situations are bad, but one is worse than the other.
Since Total Cost = Fixed Cost + Variable Cost
Firm will continue producing when revenue is greater than VC.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
12
5. To Produce or to Shut Down in SR
„
Total Revenue > Variable Cost
„
Total Revenue Variable Cost
>
Quantity
Quantity
„
Price > Average Variable Cost
„
Condition for keeping production in the short run.
When Price = Average Variable Cost
Shutdown point.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
13
5. To Produce or to Shut Down in SR
Price and cost
(dollars per
bushel)
Supply Curve
for the firm in
the short run
Marginal Cost
Average Total Cost
Average Variable Cost
P1
P2
PMIN
QSD Q2
ECON 202: Princ. of Microeconomics
Q1
Firms in Perfectly Competitive Markets
Quantity
14
5. To Produce or to Shut Down in SR
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
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6. Entry and Exit of Firms in the Long Run
„
When exist economic profit in a market, more firms are
attracted to enter.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
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6. Entry and Exit of Firms in the Long Run
„
With economic losses, some firms will leave.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
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6. Entry and Exit of Firms in the Long Run
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
18
6. Entry and Exit of Firms in the Long Run
„
In the long-run
With economic profit, entry of new firms make price decrease
until firms are breaking even.
With economic losses, exit of firms make price increase until
firms are breaking even.
Resulting situation is Long-run competitive equilibrium.
„
„
Long run competitive equilibrium price is at minimum
point of the Average Total Cost curve.
Economic profits dissapear in the long run.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
19
6. Entry and Exit of Firms in the Long Run
„
Long Run Supply Curve in a Perfectly Competitive Market
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
20
6. Entry and Exit of Firms in the Long Run
„
„
Industries with a horizontal long-run supply curve are
called constant-cost industries.
In some industries, the average cost of production can
increase if scale of production increases:
Input is available in limited amounts. (land in wine production)
Long-run supply curve is upward sloping.
Increasing-cost industry.
„
In other cases industries, the average cost of production
can fall if scale of production increases:
An input is produced at lower cost because of a higher demand.
(microchips for microwaves)
Long-run supply curve is downward sloping.
Decreasing-cost industry.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
21
7. Perfect Competition and Efficiency
„
In the long-run, firms in perfectly competitive markets will
produce at the lowest point of their average cost curve.
„
In the long-run, perfect competition results in productive
efficiency.
„
Minimizing their cost of production.
Situation in which a good is produced at the lowest possible
cost.
Also, in perfectly competitive markets, firms will use the
available resources to produce the goods that best
satisfy consumer wants.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
22
7. Perfect Competition and Efficiency
„
In perfectly competitive markets:
The price of a good represents the marginal benefit consumers
receive from consuming the last unit of the good sold.
Perfectly competitive firms produce up to the point where the
price of the good equals the marginal cost of producing the last
unit.
Therefore, firms produce up to the point where the last unit
provides a marginal benefit to consumers equal to the marginal
cost of producing it.
„
Perfect competition achieves allocative efficiency.
A state of the economy in which production represents consumer
preferences
Every good is produced up to the point where the last unit
provides a marginal benefit to consumers equal to the marginal
cost of producing it.
ECON 202: Princ. of Microeconomics
Firms in Perfectly Competitive Markets
23
ECON 202: Principles
of Microeconomics
Chapter 11
Firms in Perfectly Competitive
Markets