Chapter
11
Firms in Perfectly
Competitive Markets
Prepared by:
Fernando & Yvonn Quijano
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
Perfect Competition
in the Market for
Organic Apples
Learning Objectives
11.1 Define a perfectly competitive
market and explain why a perfect
competitor faces a horizontal
demand curve.
11.2 Explain how a firm maximizes
profits in a perfectly competitive
market.
11.3 Use graphs to show a firm’s profit
or loss.
11.4 Explain why firms may shut down
temporarily.
11.5 Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
The process of competition
is at the heart of the market
system and is the focus of
this chapter.
11.6 Explain how perfect competition
leads to economic efficiency.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
2 of 48
Firms in Perfectly Competitive Markets
Table 11-1
Chapter 11: Firms in Perfectly Competitive Markets
The Four Market Structures
MARKET STRUCTURE
CHARACTERISTIC
PERFECT
COMPETITION
MONOPOLISTIC
COMPETITION
OLIGOPOLY
MONOPOLY
Number of firms
Many
Many
Few
One
Type of product
Identical
Differentiated
Unique
Ease of entry
High
High
Identical or
differentiated
Low
Examples of
industries
• Wheat
• Apples
• Selling DVDs
• Restaurants
• Manufacturing
computers
• Manufacturing
automobiles
• First-class
mail delivery
• Tap water
Entry blocked
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
3 of 37
Learning Objective 11.1
Chapter 11: Firms in Perfectly Competitive Markets
Perfectly Competitive Markets
Perfectly competitive market A market
that meets the conditions of (1) many
buyers and sellers, (2) all firms selling
identical products, and (3) no barriers to
new firms entering the market.
A Perfectly Competitive Firm Cannot Affect the Market Price
Price taker A buyer or seller that is
unable to affect the market price.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
4 of 37
Learning Objective 11.1
Perfectly Competitive Markets
Chapter 11: Firms in Perfectly Competitive Markets
The Demand Curve for the Output
of a Perfectly Competitive Firm
FIGURE 11-1
A Perfectly Competitive Firm
Faces a Horizontal Demand
Curve
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
5 of 37
Learning Objective 11.1
Perfectly Competitive Markets
The Demand Curve for the Output
of a Perfectly Competitive Firm
Chapter 11: Firms in Perfectly Competitive Markets
FIGURE 11-2
The Market Demand for Wheat versus
the Demand for One Farmer’s Wheat
Don’t Let This Happen to YOU!
Don’t Confuse the Demand Curve for Farmer Parker’s Wheat with the Market Demand Curve for Wheat
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
6 of 37
Learning Objective 11.2
How a Firm Maximizes Profit in a Perfectly
Competitive Market
Chapter 11: Firms in Perfectly Competitive Markets
Profit Total revenue minus total cost.
Profit = TR – TC
Revenue for a Firm in a Perfectly Competitive Market
Average revenue (AR) Total revenue
divided by the quantity of the product sold.
Marginal revenue (MR) Change in total
revenue from selling one more unit of a
product.
Marginal Revenue 
Change in total revenue
TR
, or MR 
Change in quantity
Q
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
7 of 37
Learning Objective 11.2
How a Firm Maximizes Profit in a Perfectly
Competitive Market
Chapter 11: Firms in Perfectly Competitive Markets
Revenue for a Firm in a Perfectly Competitive Market
Table 11-2
Farmer Parker’s Revenue from Wheat Farming
NUMBER OF
BUSHELS
(Q)
0
1
2
3
4
5
6
7
8
9
10
MARKET PRICE
(PER BUSHEL)
(P)
TOTAL
REVENUE
(TR)
$4
4
4
4
4
4
4
4
4
4
4
$0
4
8
12
16
20
24
28
32
36
40
AVERAGE
REVENUE
(AR)
$4
4
4
4
4
4
4
4
4
4
MARGINAL
REVENUE
(MR)
$4
4
4
4
4
4
4
4
4
4
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
8 of 37
Learning Objective 11.2
How a Firm Maximizes Profit in a Perfectly
Competitive Market
Chapter 11: Firms in Perfectly Competitive Markets
Determining the Profit-Maximizing Level of Output
Table 11-3
Farmer Parker’s Profits from Wheat Farming
QUANTITY
(BUSHELS)
(Q)
TOTAL
REVENUE
(TR)
TOTAL
COSTS
(TC)
0
1
2
3
4
5
6
7
8
9
10
$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
PROFIT
(TR-TC)
–$1.00
0.00
2.00
4.50
6.50
8.00
9.00
8.50
6.50
3.50
–0.50
MARGINAL
REVENUE
(MR)
MARGINAL
COST
(MC)
—
$4.00
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
8.00
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
9 of 37
Learning Objective 11.2
How a Firm Maximizes Profit in a Perfectly
Competitive Market
Chapter 11: Firms in Perfectly Competitive Markets
Determining the Profit-Maximizing Level of Output
FIGURE 11-3
The Profit-Maximizing Level of Output
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
10 of 37
Learning Objective 11.2
How a Firm Maximizes Profit in a Perfectly
Competitive Market
Chapter 11: Firms in Perfectly Competitive Markets
Determining the Profit-Maximizing Level of Output
From the information in Table 11-3 and Figure 11-3, we
can draw the following conclusions:
1 The profit-maximizing level of output is where the
difference between total revenue and total cost
is the greatest.
2 The profit-maximizing level of output is also
where marginal revenue equals marginal cost,
or MR = MC.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
11 of 37
Learning Objective 11.3
Chapter 11: Firms in Perfectly Competitive Markets
Illustrating Profit or Loss on the Cost Curve Graph
Profit = (P x Q)  TC
( P  Q ) TC
Profit


Q
Q
Q
or
Profit
 P  ATC
Q
Profit = (P  ATC)Q
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
12 of 37
Learning Objective 11.3
Illustrating Profit or Loss on the Cost Curve Graph
Chapter 11: Firms in Perfectly Competitive Markets
Showing a Profit on the Graph
FIGURE 11-4
The Area of Maximum Profit
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
13 of 37
Learning Objective 11.3
11-3
Solved Problem
Chapter 11: Firms in Perfectly Competitive Markets
Determining Profit-Maximizing
Price and Quantity
OUTPUT
PER DAY
TOTAL
COST
MARGINAL
COST
0
$10.00
―
1
15.00
$5.00
2
17.50
2.50
3
22.50
5.00
4
30.00
7.50
5
40.00
10.00
6
52.50
12.50
7
67.50
15.00
8
85.00
17.50
9
105.00
20.00
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
14 of 37
Learning Objective 11.3
Illustrating Profit or Loss on the Cost Curve Graph
Don’t Let This Happen to YOU!
Chapter 11: Firms in Perfectly Competitive Markets
Remember That Firms Maximize Total Profit, Not Profit per Unit
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
15 of 37
Learning Objective 11.3
Illustrating Profit or Loss on the Cost Curve Graph
Chapter 11: Firms in Perfectly Competitive Markets
Illustrating When a Firm Is Breaking Even
or Operating at a Loss
1 P > ATC, which means the firm makes a profit.
2 P = ATC, which means the firm breaks even (its total
cost equals its total revenue).
3 P < ATC, which means the firm experiences losses.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
16 of 37
Learning Objective 11.3
Illustrating Profit or Loss on the Cost Curve Graph
Chapter 11: Firms in Perfectly Competitive Markets
Illustrating When a Firm Is Breaking Even
or Operating at a Loss
FIGURE 11-5
A Firm Breaking Even and a Firm Experiencing Losses
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
17 of 37
Learning Objective 11.3
Making
the
Chapter 11: Firms in Perfectly Competitive Markets
Connection
Losing Money in the
Medical Screening Industry
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
18 of 37
Learning Objective 11.4
Chapter 11: Firms in Perfectly Competitive Markets
Deciding Whether to Produce
or to Shut Down in the Short Run
In the short run, a firm suffering losses has
two choices:
1 Continue to produce
2 Stop production by shutting down
temporarily
Sunk cost A cost that has already been
paid and that cannot be recovered.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
19 of 37
Learning Objective 11.3
Making
the
When to Close a Laundry
Chapter 11: Firms in Perfectly Competitive Markets
Connection
Keeping a business open
even when suffering losses
can sometimes be the best
decision for an entrepreneur in
the short run.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
20 of 37
Learning Objective 11.4
Deciding Whether to Produce
or to Shut Down in the Short Run
Chapter 11: Firms in Perfectly Competitive Markets
The Supply Curve of a Firm in the Short Run
Total revenue < Variable cost,
or, in symbols:
P × Q < VC
If we divide both sides by Q, we have the result that
the firm will shut down if:
P < AVC
Shutdown point The minimum point on a firm’s
average variable cost curve; if the price falls below this
point, the firm shuts down production in the short run.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
21 of 37
Learning Objective 11.4
Deciding Whether to Produce
or to Shut Down in the Short Run
Chapter 11: Firms in Perfectly Competitive Markets
The Supply Curve of a Firm in the Short Run
FIGURE 11-6
The Firm’s Short-Run Supply Curve
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
22 of 37
Learning Objective 11.4
Deciding Whether to Produce
or to Shut Down in the Short Run
Chapter 11: Firms in Perfectly Competitive Markets
The Market Supply Curve in a Perfectly Competitive Industry
FIGURE 11-7
Firm Supply and Market Supply
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
23 of 37
Learning Objective 11.5
“If Everyone Can Do It, You Can’t Make Money at It”:
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
Chapter 11: Firms in Perfectly Competitive Markets
Table 11- 4
Farmer Moreno’s Costs per Year
EXPLICIT COSTS
Water
Wages
Organic fertilizer
Electricity
Payment on bank loan
$10,000
$15,000
$10,000
$5,000
$45,000
IMPLICIT COSTS
Foregone salary
Opportunity cost of the $100,000 she has invested in her farm
Total Cost
$30,000
$10,000
$125,000
Economic profit A firm’s revenues
minus all its costs, implicit and explicit.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
24 of 37
Learning Objective 11.5
“If Everyone Can Do It, You Can’t Make Money at It”:
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
Chapter 11: Firms in Perfectly Competitive Markets
Economic Profit Leads to Entry of New Firms
FIGURE 11-8
The Effect of Entry on Economic Profits
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
25 of 37
Learning Objective 11.5
“If Everyone Can Do It, You Can’t Make Money at It”:
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
Chapter 11: Firms in Perfectly Competitive Markets
Economic Losses Lead to Exit of Firms
FIGURE 11-9
The Effect of Exit on Economic Losses
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
26 of 37
Learning Objective 11.5
“If Everyone Can Do It, You Can’t Make Money at It”:
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
Chapter 11: Firms in Perfectly Competitive Markets
Economic Losses Lead to Exit of Firms
FIGURE 11-9
The Effect of Exit on Economic Losses (continued)
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
27 of 37
Learning Objective 11.5
“If Everyone Can Do It, You Can’t Make Money at It”:
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
Chapter 11: Firms in Perfectly Competitive Markets
Economic Losses Lead to Exit of Firms
Economic loss The situation in which
a firm’s total revenue is less than its
total cost, including all implicit costs.
Long-Run Equilibrium in a Perfectly Competitive Market
Long-run competitive equilibrium
The situation in which the entry and exit
of firms has resulted in the typical firm
breaking even.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
28 of 37
Learning Objective 11.5
“If Everyone Can Do It, You Can’t Make Money at It”:
The Entry and Exit of Firms in the Long Run
Chapter 11: Firms in Perfectly Competitive Markets
The Long-Run Supply Curve in a Perfectly Competitive Market
FIGURE 11-10
The Long-Run Supply Curve in a Perfectly Competitive Industry
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
29 of 37
Learning Objective 11.5
“If Everyone Can Do It, You Can’t Make Money at It”:
The Entry and Exit of Firms in the Long Run
Chapter 11: Firms in Perfectly Competitive Markets
The Long-Run Supply Curve in a Perfectly Competitive Market
Long-run supply curve A curve that
shows the relationship in the long run
between market price and the quantity
supplied.
Increasing-Cost and Decreasing-Cost Industries
Industries with upward-sloping long run supply
curves are called increasing-cost industries.
Industries with downward-sloping long-run supply
curves are called decreasing-cost industries.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
30 of 37
Learning Objective 11.6
Making
the
Chapter 11: Firms in Perfectly Competitive Markets
Connection
The Decline of Apple Production
in New York State
When apple growers in New York State stopped breaking
even, many sold their land to housing developers.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
31 of 37
Learning Objective 11.6
Perfect Competition and Efficiency
Chapter 11: Firms in Perfectly Competitive Markets
Productive Efficiency
Productive efficiency The
situation in which a good or service
is produced at the lowest possible
cost.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
32 of 37
Learning Objective 11.6
Solved Problem
11-6
Chapter 11: Firms in Perfectly Competitive Markets
How Productive Efficiency Benefits Consumers
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
33 of 37
Learning Objective 11.6
Perfect Competition and Efficiency
Chapter 11: Firms in Perfectly Competitive Markets
Allocative Efficiency
Firms will supply all those goods that provide consumers with
a marginal benefit at least as great as the marginal cost of
producing them.
1 The price of a good represents the marginal benefit
consumers receive from consuming the last unit of
the good sold.
2 Perfectly competitive firms produce up to the point
where the price of the good equals the marginal
cost of producing the last unit.
3 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.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
34 of 37
Learning Objective 11.6
Perfect Competition and Efficiency
Chapter 11: Firms in Perfectly Competitive Markets
Allocative Efficiency
Allocative efficiency A state of the
economy in which production represents
consumer preferences; in particular,
every good or service is produced up to
the point where the last unit provides a
marginal benefit to consumers equal to
the marginal cost of producing it.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
35 of 37
An Inside LOOK
Why Are Organic Farmers
Worried about Wal-Mart?
Chapter 11: Firms in Perfectly Competitive Markets
Wal-Mart’s Organic Offensive
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
36 of 37
Chapter 11: Firms in Perfectly Competitive Markets
Key Terms
Allocative efficiency
Perfectly competitive market
Average revenue (AR)
Price taker
Economic loss
Productive efficiency
Economic profit
Profit
Long-run competitive equilibrium
Shutdown point
Long-run supply curve
Sunk cost
Marginal revenue (MR)
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
37 of 37