CHAPTER
12
Competition
Competition
 What is perfect competition?
 How are price and output determined
in a competitive industry?
 Why do firms enter and leave an
industry?
 How do changes in demand and
technology affect an industry?
 Why is perfect competition
economically efficient?
Perfect Competition
 Perfect competition arises when:
 There are many firms, each selling an
identical product.
 There are many buyers.
 There are no restrictions on entry into
the industry.
 Firms in the industry have no advantage
over potential new entrants.
 Firms and buyers are completely
informed about other firms’ prices.
The Firm Has No Control
Over the Price It Charges
 Since each firm produces a small
fraction of total industry output and
the products are identical, no firm
has any control over price.
 Firms are price takers in perfectly
competitive markets. A price taker is
a firm that cannot influence the price
of a good or service.
Elasticity of Industry
and Firm Demand
 A price taker firm faces a demand
curve that is perfectly elastic
(horizontal) because the product
from firm A is a perfect substitute for
the product from firm B.
 However, the market demand curve
will still slope downward; elasticity
will be positive, but not infinite.
Competition in
the Real World
 In reality, there are no markets that
are absolutely perfectly competitive.
 However, competition in some
industries is so fierce that the model
of perfect competition predicts
extremely well how firms will behave.
 Examples are computers, soft drinks,
TVs, DVD players, potato chips, etc.
Economic Profit and Revenue
 Total revenue (TR)
 Value of a firm’s sales
 TR = P  Q
 Marginal revenue (MR)
 Change in total revenue resulting from a oneunit increase in quantity sold.
 MR =
TR/ Q
 Average revenue (AR)
 Total revenue divided by the quantity sold —
revenue per unit sold.
 AR = TR/Q = PxQ/Q = P
 In perfect competition, Price = MR = AR
Economic Profit and
Revenue
Suppose Cindy sells her sweaters
in a perfectly competitive market.
What are Cindy’s TR, MR, and AR?
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
8
25
9
25
10
25
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
8
25
9
25
10
25
200
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
8
25
200
9
25
225
10
25
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
8
25
200
9
25
225
10
25
250
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
8
25
200
9
25
225
10
25
250
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
-
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
8
25
200
-
9
25
225
25
10
25
250
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
8
25
200
-
9
25
225
25
10
25
250
25
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
8
25
200
-
9
25
225
25
10
25
250
25
25
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
8
25
200
-
25
9
25
225
25
25
10
25
250
25
Demand, Price, and Revenue
in Perfect Competition
Quantity Price
sold
(P)
Total
(Q)
(dollars revenue
(sweaters
per day)
per
TR = P ´ Q
sweater) (dollars)
Marginal
revenue
Average
revenue
MR   TR /  Q
AR = TR/Q
(dollars per
(dollars
additional sweater) per sweater)
8
25
200
-
25
9
25
225
25
25
10
25
250
25
25
Demand, Price, and
Revenue
in Perfect Competition
Cindy’s demand,
average revenue, and
marginal revenue
50
50
25
25
0
Total revenue (dollar per day)
Price (dollars per sweater)
Price (dollars per sweater)
Sweater Industry
9
20
Quantity (thousands
of sweaters per day)
0
Cindy’s total
revenue
225
10
20
0
Quantity (sweaters per day)
9
20
Quantity (sweaters per day)
Demand, Price, and
Revenue
in Perfect Competition
Total revenue (dollar per day)
Price (dollars per sweater)
Price (dollars per sweater)
Sweater Industry
50
50
S
25
25
225
D
0
9
20
Quantity (thousands
of sweaters per day)
0
10
20
0
Quantity (sweaters per day)
9
20
Quantity (sweaters per day)
Demand, Price, and
Revenue
in Perfect Competition
Price (dollars per sweater)
Price (dollars per sweater)
Sweater Industry
50
50
S
Cindy’s
demand
curve
AR=
MR
25
25
Total revenue (dollar per day)
Cindy’s demand,
average revenue, and
marginal revenue
225
D
0
9
20
Quantity (thousands
of sweaters per day)
0
10
20
0
Quantity (sweaters per day)
9
20
Quantity (sweaters per day)
Demand, Price, and
Revenue
in Perfect Competition
Cindy’s demand,
average revenue, and
marginal revenue
50
50
S
Cindy’s
demand
curve
AR=
MR
25
25
Total revenue (dollar per day)
Price (dollars per sweater)
Price (dollars per sweater)
Sweater Industry
Cindy’s total
revenue
TR
225
a
D
0
9
20
Quantity (thousands
of sweaters per day)
0
10
20
0
Quantity (sweaters per day)
9
20
Quantity (sweaters per day)
Economic Profit and
Revenue
 The firm’s goal is to maximize
economic profit.
 Total cost is the opportunity cost —
including normal profit.
The Firm’s Decisions in
Perfect Competition
 A firm’s task is to make the
maximum economic profit possible,
given the constraints it faces.
 In order to do so, the firm must make
two decisions in the short-run, and
two in the long-run.
The Firm’s Decisions in
Perfect Competition
 Short-run
 A time frame in which each firm has a
given plant and the number of firms in
the industry is fixed
 Long run
 A time frame in which each firm can
change the size of its plant and decide
whether to leave or stay in the industry.
The Firm’s Decisions in
Perfect Competition
 In the short-run, the firm must
decide:
 Whether to produce or to shut down.
 If the decision is to produce, what
quantity to produce.
 Price is not a decision because firm is a
price taker.
The Firm’s Decisions in
Perfect Competition
 In the long-run, the firm must decide:
 Whether to increase of decrease its
plant size
 Whether to stay in the industry or leave
it
We will first address the shortrun.
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
40
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
40
42
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
40
42
40
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
40
42
40
30
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
40
42
40
30
0
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
40
42
40
30
0
-35
Total Revenue, Total Cost,
and Economic Profit
Quantity Total
(Q)
revenue
(sweaters
(TR)
Per day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
(dollars)
0
25
50
75
100
125
150
175
200
225
250
275
300
325
Total
cost
(TC)
(dollars)
22
45
66
85
100
114
126
141
160
183
210
245
300
360
Economic
profit
(TR – TC)
(dollars)
-22
-20
-16
-10
0
11
24
34
40
42
40
30
0
-35
Total revenue & total cost
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
Revenue
and Cost
300
225
183
100
0
4
9
12
Quantity (sweaters per day)
Total revenue & total cost
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
TR
300
225
183
100
0
4
9
12
Quantity (sweaters per day)
Revenue
and Cost
Total revenue & total cost
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
TC
TR
300
225
183
100
0
4
9
12
Quantity (sweaters per day)
Revenue
and Cost
Total revenue & total cost
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
TC
TR
300
225
Economic
profit =
TR - TC
183
100
Economic
loss
0
4
9
12
Quantity (sweaters per day)
Revenue
and Cost
Profit/loss
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
Economic
profit/loss
42
20
0
-20
-40
4
9
12
Profit/
loss
Quantity
(sweaters
per day)
Profit/loss
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
Economic
profit/loss
42
20
0
4
-20
-40
Economic
profit
Economic
loss
Profit
maximizing
quantity
9
12
Profit/
loss
Quantity
(sweaters
per day)
Profit/loss
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
MR=MC
MR>MC
MR<MC
42
20
0
4
-20
-40
Profit
maximizing
quantity
9
12
Profit/
loss
Quantity
(sweaters
per day)
Break-even Output
 An output at which total cost equals
total revenue is called a break-even
point.
 Even though economic profit is zero
at break-even output, the firm still
earns a normal profit.
 Remember, normal profit is part of
total (opportunity) cost.
Total revenue & total cost
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
TC
TR
300
225
Breakeven Points
183
100
0
4
9
12
Quantity (sweaters per day)
Profit/loss
(dollars per day)
Total Revenue, Total Cost,
and Economic Profit
Breakeven Point
Breakeven Point
42
20
0
4
-20
-40
Profit
maximizing
quantity
9
12
Profit/
loss
Quantity
(sweaters
per day)
Marginal Analysis
 Using marginal analysis, a
comparison is made between a units
marginal revenue and marginal cost.
Marginal Analysis
 If MR > MC, the extra revenue from selling
one more unit exceeds the extra cost.
 The firm should increase output to increase
profit
 If MR < MC, the extra revenue from selling
one more unit is less than the extra cost.
 The firm should decrease output to increase
profit
 If MR = MC economic profit is maximized.
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
-
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
-
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
-
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
23
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
25
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
23
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
25
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
23
27
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
25
25
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
23
27
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
25
25
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
23
27
35
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Profit-Maximizing Output
Quantity
Total
Marginal
revenue
(MR)
(Q) revenue (dollars per
(sweaters (TR)
additional
per day) (dollars)
7
8
9
10
11
175
200
225
250
275
sweater)
25
25
25
25
Total
Marginal
cost
(MC)
cost
(TC)
(dollars per
additional
(dollars sweater)
141
160
183
210
245
19
23
27
35
Economic
profit
(TR – TC)
(dollars)
34
40
42
40
30
Marginal revenue & marginal cost
(dollars per day)
Profit-Maximizing Output
30
25
20
10
8 9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
Profit-Maximizing Output
30
25
MR = AR = P
20
10
8 9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
Profit-Maximizing Output
MC
30
25
MR = AR = P
20
10
8 9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
Profit-Maximizing Output
30
Profitmaximization
point
Loss from
10th sweater
MR = AR = P
25
20
MC
Profit from
9th sweater
10
8 9 10
Quantity (sweaters per day)
Economic Profit
in the Short Run
 Maximizing economic profit does not
guarantee that profits will be
positive.
 Economic profit can be positive,
negative or zero.
 To calculate total profit, we must
subtract total cost from total
revenue.
Price, Average Total Cost,
and Profit
 Price is total revenue per unit, or
average revenue (P=AR=TR/Q)
 Average total cost is total cost per
unit (ATC=TC/Q).
 Profit = TR - TC
 Profit per unit=(TR-TC)/Q=TR/Q-TC/Q

= (P - ATC)
 That means we can calculate total
profit as (P - ATC)xQ.
Profits and Losses
in the Short-Run
 As we indicated, at short-run
equilibrium firms may:
 Earn a profit
 Break even
 Incur an economic loss.
Profits and Losses
in the Short-Run
 If price equals average total cost
(P=ATC), a firm breaks even.
 If price exceeds average total cost
(P>ATC), a firm makes an economic
profit.
 If price is less than average total cost
(P<ATC), a firm incurs an economic
loss.
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
MC
25.00
Possible
ATC
Outcome One
P=ATC
20.00
15.00
8
10
Quantity (millions of chips per year)
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
Break-even
point
25.00
20.00
MC
Possible
ATC
Outcome One
P=ATC
Profits=(P-ATC)xQ
=(20-20)x8 = 0
AR = MR = P
15.00
8
10
Quantity (millions of chips per year)
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Two
P>ATC
25.00
20.00
15.00
8
10
Quantity (millions of chips per year)
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Two
P>ATC
25.00
AR = MR = P
20.33
15.00
Profits
=(P-ATC)xQ
=(25-20.33)x9
=4.67x9=42
9 10
Quantity (millions of chips per year)
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Two
P>ATC
25.00
Economic Profit
20.33
15.00
AR = MR = P
Profits
=(P-ATC)xQ
=(25-20.33)x9
=4.67x9=42
9 10
Quantity (millions of chips per year)
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Three
P<ATC
25.00
20.00
15.00
9 10
Quantity (millions of chips per year)
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Three
P<ATC
25.00
Profits
=(P-ATC)xQ
=(17-20.14)x7
=-22
20.14
17.00
AR = MR = P
7
10
Quantity (millions of chips per year)
Price (dollars per chip)
Three Possible Profit
Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Three
P<ATC
25.00
20.14
Economic Loss
17.00
Profits
=(P-ATC)xQ
=(17-20.14)x7
=-22
AR = MR = P
7
10
Quantity (millions of chips per year)
Three Possible Profit
Outcomes in the Short-run
The Firm’s Short-Run
Supply Curve
 Fixed costs must be paid in the
short-run.
 Variable-costs can be avoided by
laying off workers and shutting
down.
 Firms shut down if price falls below
the minimum of average variable
cost.
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
31
25
17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
31
ATC
25
AVC
17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
MC
31
ATC
25
AVC
17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
MC
31
25
MR1=P1=25
AVC
17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
MC
31
MR2=P2=31
25
AVC
17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
MC
31
25
Shutdown
point
s
17
AVC
MR0=P0=17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
MC = Supply
31
MR2=P2=31
25
MR1=P1=25
AVC
s
17
MR0=P0=17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
S = MC
31
25
AVC
s
17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
S = MC
31
25
AVC
s
17
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
A Firm’s Supply Curve
S = MC
31
25
s
17
7
9 10
Quantity (sweaters per day)
The Firm’s Short-Run
Supply Curve
 A perfectly competitive firm’s short-run
supply curve shows how its profitmaximizing output varies as market price
changes.
 Since price must equal marginal cost, the
marginal cost curve is also the supply
curve.
 However, only the portion of the marginal
cost curve above the minimum average
variable cost curve is relevant.
Temporary Plant Shutdown
 A firm cannot avoid incurring its fixed
costs but it can avoid variable costs.
 A firm that shuts down and produces no
output incurs a loss equal to its total fixed
cost.
 A firm’s shutdown point is the level of
output and price where the firm is just
covering its total variable cost.
 In other words, if its losses are bigger
than its fixed costs, the firm will shut
down.
Production Decisions
 When price is below the minimum
point of the AVC curve, the firm will
shut down and supply zero output.
 When price is above the lowest point
of the AVC curve, the firm will
produce the level of output where
price equals marginal cost.
 The short-run supply curve is
therefore the MC curve above the
AVC curve.
Output, Price, and Profit
in the Long Run
 In short-run equilibrium, a firm might
make an economic profit, incur an
economic loss, or break even (make
a normal profit). Only one of these
situations is a long-run equilibrium.
 In the long run either the number of
firms in an industry changes or firms
change the scale of their plants.
Economic Profit and
Economic Loss as Signals
 If an industry is earning above
normal profits (positive economic
profits), firms will enter the industry
and begin producing output.
 This will shift the industry supply
curve out, lowering price and profit.
Economic Loss as a Signal
 If an industry is earning below
normal profits (negative economic
profits), some of the weaker firms
will leave the industry.
 This shifts the industry supply curve
in, raising price and profit.
Long-Run Adjustments
 Forces in a competitive industry
ensure only one of these situations
is possible in the long-run.
 Competitive industries adjust in two
ways:
 Entry and exit
 Changes in plant size
Entry and Exit
 The prospect of persistent profit or
loss causes firms to enter or exit an
industry.
 If firms are making economic profits,
other firms enter the industry.
 If firms are making economic losses,
some of the existing firms exit the
industry.
Entry and Exit
 This entry and exit of firms influence
price, quantity, and economic profit.
Let’s investigate the effects of
firms entering or exiting an
industry.
Price (dollars per sweater)
Entry
S1
23
20
17
D1
6
7
8
9
10
Quantity (thousands of sweaters per day)
Price (dollars per sweater)
Entry
S1
S0
23
20
17
D1
6
7
8
9
10
Quantity (thousands of sweaters per day)
Price (dollars per sweater)
Exit
S2
23
20
17
D1
6
7
8
9
10
Quantity (thousands of sweaters per day)
Price (dollars per sweater)
Exit
S0
S2
23
20
17
D1
6
7
8
9
10
Quantity (thousands of sweaters per day)
Price (dollars per sweater)
Entry and Exit
S1
S0
S2
23
20
17
D1
6
7
8
9
10
Quantity (thousands of sweaters per day)
Entry and Exit
Important Points
 As new firms enter an industry, the
price falls and the economic profit of
each existing firm decreases.
 As firms leave an industry, the price
rises and the economic loss of each
remaining firm decreases.
Long-Run Equilibrium
 Long-run equilibrium occurs in a
competitive industry when firms are
earning normal profit and economic
profit is zero.
 Economic profits draw in firms and
cause existing firms to expand.
 Economic losses cause firms to
leave and cause existing firms to
scale back.
Long-Run Equilibrium
 So in long-run equilibrium in a
competitive industry, firms neither
enter nor exit the industry and firms
neither expand their scale of
operation nor downsize.
Long-Run Equilibrium
 In long-run equilibrium, firms will be
earning only a normal profit.
Economic profits will be zero.
 Firms will neither enter nor exit the
industry.
 In long run equilibrium, P=MC and
P=ATC. Thus, P=MC=ATC.
 Because MC=ATC, ATC must be at
its minimum.
Changing Tastes and
Advancing Technology
What happens in a competitive
industry when a permanent
change in demand occurs?
A Decrease in Demand
Firm
0
Price and Cost
Price
Industry
Quantity
Quantity
A Decrease in Demand
Industry
Firm
MC
Price and Cost
Price
S0
P0
ATC
MR0
P0
D0
0
Q0
Quantity
q0
Quantity
A Decrease in Demand
Industry
Firm
MC
Price and Cost
Price
S0
P0
P0
P1
P1
ATC
MR0
MR1
D0
D1
0
Q1
Q0
Quantity
q1
q0
Quantity
A Decrease in Demand
Firm
Price
S0
P1
MC
Price and Cost
Industry
ATC
MR1
P1
D1
0
Q1
Quantity
q1
Quantity
Industry
S1
S0
Firm
MC
Price and Cost
Price
A Decrease in Demand
P0
P0
P1
P1
ATC
MR0
MR1
D1
0
Q2 Q1
Quantity
q1
q0
Quantity
A Decrease in Demand
P0
Firm
MC
Price and Cost
Price
Industry
S1
S0
ATC
MR0
P0
MR1
D1
0
Q2
Quantity
q0
Quantity
Industry
S1
S0
Summary
Firm
MC
Price and Cost
Price
A Decrease in Demand
P0
P0
P1
P1
ATC
MR0
MR1
D0
D1
0
Q2 Q1
Q0
Quantity
q1
q0
Quantity
Changing Tastes and
Advancing Technology
 Technological change
 New technology allows firms to produce
at lower costs.
• This causes their cost curves to shift downward.
 Firms adopting the new technology
make an economic profit.
• This draws in new technology firms
 Old technology firms disappear, the
price falls, and the quantity produced
increases.
Changing Tastes and
Advancing Technology
 A competitive industry is rarely in a
long-run equilibrium.
 What happens in a competitive
industry when there is a permanent
increase or decrease in the demand
for its product?
 What happens in a competitive
industry when technological change
lowers its production costs?
A Permanent Change
in Demand
 A permanent decrease in demand
will cause the short-run equilibrium
price and quantity to fall.
 In the long run, firms will leave the
industry (because economic profits
are negative), raising price enough to
restore a normal level of profit.
 The difference is the number of firms
in the industry.
A Permanent Increase
in Demand
 The increase in demand causes
industry price and profits to rise.
 Firms enter the industry, increasing
market supply and eventually
lowering price to its original level.
 However there are now more firms in
the industry.
Technological Change
 Technological improvements lower
average cost of production.
 Most technological improvements
cannot be implemented without
investment in new plant and
equipment.
 This means it takes time for a
technological advance to spread
through an industry.
Technological Change and
Equilibrium Price
 A technological improvement that
affects all firms will shift the industry
supply curve down and to the right.
 Firms now earn economic profits and
new firms enter the industry.
 This this drives down equilibrium
price and raises industry output.
Technological Change and
Equilibrium Profit
 Implementing a technological
improvement causes the marginal
cost curve for each firm to shift down
and to the right.
 Economic profits are not affected in
the long run.
 The firms that survive in the long run
are those that adopted the new
technology early.