Chapter 7 Market Structure: Perfect Competition
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Economics for Managers by y Paul Farnham Chapter 7 Market Structure: Perfect Competition © 2005 Prentice Hall, Inc. 7.1 Perfect Competition Characterized by • A large number of firms in the market • An undifferentiated product • Ease of entry into the market • Complete information available to all market participants © 2005 Prentice Hall, Inc. 7.2 Perfect Competition Distinguishes between behavior of individual firms and outcomes f entire for ti market k t No single firm has any influence on the th price i off a product d t Price-taker: a firm cannot i fl influence the th price i off its it product, d t thus it can sell any amount of output at that price © 2005 Prentice Hall, Inc. 7.3 Perfectly Competitive Figure 7.1 Industry/Market Individual Firm MC S PE ATC B A P=MR D 0 QE © 2005 Prentice Hall, Inc. Q 0 Q1 Q2 Q 7.4 Profit Maximization = TR - TC where = profit TR = total revenue TC = total cost Profit-maximization P fit i i ti rule: l to t maximize i i profits, a firm should produce the level of p where marginal g revenue equals q output marginal cost © 2005 Prentice Hall, Inc. 7.5 Determining the Amount off P Profit fit E Earned d If you know total revenue and total cost,, you y can calculate amount of profit Using TR and TC function graphs, you can calculate level of profitmaximizing g by y finding g the greatest distance between the two curves and calculate the profit at th t point that i t © 2005 Prentice Hall, Inc. 7.6 The Shutdown Point The shutdown point for perfectly competitive p firm: the p price,, which just equals AVC, below which it is more profitable for the perfectly competitive titi firm fi to t shut h t down d than to continue to produce The supply curve is that portion of its marginal cost curve above minimum i i AVC © 2005 Prentice Hall, Inc. 7.7 Supply Curve for Perfectly C Competitive titi Industry I d t The supply curve shows the output p produced p by y all perfectly p y competitive firms in the industry at different prices The curve will be flatter than the firm’s supply pp y curve because it reflects output produced by all firms in the industry at each price © 2005 Prentice Hall, Inc. 7.8 Long-run Long run Adjustment Two factors: • Entry and exit by new and existing firms • Changes in the scale of operations by all firms These Th factors f t can occur simultaneously © 2005 Prentice Hall, Inc. 7.9 Long-run Long run Adjustment Equilibrium point for the perfectly competitive p firm: the p point where price equals ATC since the firm earns zero economic profit at this point i t Economic p profit incorporates p all implicit costs of production including normal rate of return on i investment t t © 2005 Prentice Hall, Inc. 7.10 Long-run Adjustment: E t and Entry d Exit E it Figure 7.3 Industry/Market Individual Firm S1 MC ATC S2 PE2 D2=P2=MR2 PE1 A B D1 D2 0 QE1 QE2 QE3 © 2005 Prentice Hall, Inc. 0 D1=P1=MR1 Q1 Q2 7.11 Long-run Long run Adjustment Firm is a price-taker; therefore, it must accept p new equilibrium q price p and determine appropriate level of output All firms know the positive economic profits p Other firms are able to enter the market © 2005 Prentice Hall, Inc. 7.12 Optimum Scale off P Production d ti SMC1 SATC1 SMC2 SATC2 Figure 7.5 LRAC P1=MR1 P2=MR2 0 Q1 © 2005 Prentice Hall, Inc. Q2 Q 7.13 Optimum Scale off P Production d ti In Figure 7.5, LRAC incorporates both economies of scale and diseconomies of scale Large Large-scale scale production will give managers competitive edge by decreasing g production p costs Cannot influence price of product © 2005 Prentice Hall, Inc. 7.14 Managerial Rule of Thumb: Competition Means Little Control Over Price Managers have little or no control over p product price p They compete on basis of lowering costs of production Perfectly competitive firms earn zero economic profit because entry of other firms compete away excess profit © 2005 Prentice Hall, Inc. 7.15 Other Competitive M k t Markets Industry concentration: measure of how many y firms p produce the total output of an industry Price Price-cost cost margin (PCM): relationship between price and costs for an industry y © 2005 Prentice Hall, Inc. 7.16 Managerial Rule of Thumb: St t i Strategies to t Gain G i Market M k t Power P Managers in competitive industries can g gain market power p by y • Merging with other companies • Differentiating products • Forming producer association to change h consumer preferences f and increase demand for output of the entire industry © 2005 Prentice Hall, Inc. 7.17 Summary of Key Terms Diseconomies of scale Economies of scale Equilibrium point for the perfectly competitive firm I d t concentration Industry t ti Marginal revenue curve for the perfectly f tl competitive titi firm fi Competitive firm Perfect competition © 2005 Prentice Hall, Inc. 7.18 Summary of Key Terms Price-cost Price cost margin (PCM) Price taker Profit maximization Shutdown point for the perfectly y competitive titi fi firm Supply curve for the perfectly competitive titi fi firm Supply curve for the perfectly competitive industry © 2005 Prentice Hall, Inc. 7.19
