Perfect Competition
CHAPTER 10
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Perfect Competition
Perfect competition is a firm behavior that occurs when many firms produce identical products and entry is easy.
Characteristics of perfect competition:
◦ There are many sellers.
◦ The products sold by all the firms in the industry are identical.
◦ Entry into and exit from the market are easy, and there are many potential entrants.
◦ Buyers (consumers) and sellers (firms) have perfect information.
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Price Taker
A firm in a perfectly competitive market is said to be a price taker because the price of the product is determined by market supply and demand, and the individual firm can do nothing to change that price.
The result is that the individual firm perceives the demand curve for its product as being perfectly horizontal .
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Market Supply and Demand and Single-Firm Demand
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Profit Maximization
Profit is maximized where MR=MC.
◦ If the cost of producing one more unit is less than the revenue it generates, then a profit is available for the firm that increases production by one unit.
◦ If the cost of producing one more unit is more than the revenue it generates, then increasing production reduces profit.
◦ Thus the firm will stop increasing production at the point at which it stops being profitable to do so— where MR=MC.
◦ Graphically this occurs where the MC curve crosses the MR curve.
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Profit Maximization: The
Numbers
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Profit Maximization: Graphical
Analysis
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Determining Profit or Loss
MR=MC is the profit-maximizing or loss-minimizing output level.
The perfectly elastic demand curve (the price line and the marginalrevenue curve) is affected by price changes.
Profit or loss is determined by finding the quantity at which the marginal-revenue curve equals the marginal-cost curve.
If the demand curve is above the ATC curve, the firm is making a profit.
If the ATC curve exceeds the price line, the firm is suffering a loss.
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Loss Minimization: The
Numbers
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Loss Minimization: Graphical
Analysis
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Minimizing Loss
Shutdown price : the minimum point of the averagevariable-cost (AVC) curve.
Break-even price : A price that is equal to the minimum point of the average-total-cost (ATC) curve.
At this price, economic profit is zero.
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Shutdown Price
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The Long Run
The short run is a timeframe in which at least one of the resources used in production cannot be changed.
Exit and entry are long-run phenomena.
In the long run , all quantities of resources can be changed.
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Normal Profit in the Long Run
Entry and exit occur whenever firms are earning more or less than
“normal profit” (zero economic profit).
◦ If firms are earning more than normal profit, other firms will have an incentive to enter the market.
◦ If firms are earning less than normal profit, firms in the industry will have an incentive to exit the market.
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Economic Profit in the Long
Run
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The Predictions of the Model of Perfect Competition
A zero economic profit is a normal accounting profit , or just normal profit .
Firms produce where marginal cost equals price.
No one could be made better off without making someone else worse off. Economists refer to this result as economic efficiency .
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Consumer and Producer
Surplus
Consumer surplus : the difference between what the consumers would have been willing and able to pay for a product and the price they actually have to pay to buy the product.
Producer surplus : the difference between the price firms would have been willing and able to accept for their products and the price they actually receive for them.
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Consumer and Producer
Surplus
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