Chapter 10 THE FIRM AND THE INDUSTRY UNDER PERFECT

8

The Firm and the Industry

Under Perfect Competition

Competition . . . brings about the only . . . arrangement of social production which is possible. . . . [Otherwise] what guarantee [do] we have that the necessary quantity and not more of each product will be produced, that we shall not go hungry in regard to corn and meat while we are choked in beet sugar and drowned in potato spirit, that we shall not lack trousers to cover our nakedness while buttons flood us in millions?

FRIEDRICH ENGELS (THE FRIEND AND CO-AUTHOR OF KARL MARX)

Contents

●

Perfect Competition Defined

●

The Competitive Firm

●

The Competitive Industry

●

Perfect Competition and Economic

Efficiency

Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Perfect Competition Defined

●

Four Principal Market Types

♦

Perfect competition

♦

Monopolistic competition

♦

Oligopoly

♦

Pure monopoly

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Perfect Competition Defined

●

Perfect competition

♦

Many small firms and customers

♦

Homogeneous product

♦

Free entry and exit

♦

Well-informed producers and consumers


The Competitive Firm

●

Perfect competition

♦

Firm is a price taker.

♦

Price is set in the market.

♦

Firm is too small to affect the market.



● The Firm’s Demand Curve under Perfect

Competition

♦

Horizontal

♦

Can sell as much as it wants at the market price.


FIGURE

8-1 Demand Curve for a

Firm under Perfect Competition

$3

A B C

Firm’s demand curve

0 1 2 3 4

Truckloads of Corn

Sold by Farmer Jasmine per Year

(a)

$3

D Industry supply curve

E

S

Industry demand curve

0

S

D

100 200 300 400

Total Sales in Chicago in Thousands of Truckloads per Year

(b)



●

Short-Run Equilibrium for the Perfectly

Competitive Firm

♦

Marginal revenue = price

♦

Profit-maximizing level of output: marginal cost = price

♦

MC = MR


TABLE

8-1 Revenues, Costs, and

Profits of a Competitive Firm



●

D = MR = AR at all levels of output

●

D = MR = AR = MC at the equilibrium level of output


FIGURE

8-2 S-R Equilibrium of the Competitive Firm

$3.00

2.25

1.50

0

B

MC AC

D = MR = AR

A

50,000

Bushels of Corn per Year


Short-Run Profit: Graphic

Representation

●

The MC = P condition does not show if the firm is making a profit or incurring a loss.

●

Compare price (average revenue) with average cost to calculate profit or loss per unit.

●

The profit-maximizing output may lead to a loss, but if so it is the minimum possible loss.


FIGURE

8-3 S-R Equilibrium of

Competitive Firm w/Lower Price

MC AC

$2.25

1.50

0

A

B D = MR = P

30,000

Bushels of Corn per Year


Short-Run Profit: Graphic

Representation

●

The MC = P condition does not show if the firm is making a profit or incurring a loss.

●

Compare price (average revenue) with average cost to calculate profit or loss per unit.

●

The profit-maximizing output may lead to a loss, but if so it is the minimum possible loss.


Shutdown and Break-Even

Analysis

●

Rule 1: The firm will make a profit if total revenue (TR) > total cost (TC)

●

Should not plan to shut down in either the short run or the long run.


Shutdown and Breakeven

Analysis

●

Rule 2: Even if TR < TC, the firm should continue to operate in the short run as long as TR > TVC.

●

If TR > TVC, the firm can at least pay some of its fixed costs.

●

The firm should close in the long run if TR

< TC.


TABLE

8-2 The Shutdown

Decision


Shutdown and Breakeven

Analysis

●

The competitive firm will produce nothing unless price lies above the minimum point on the AVC curve.


FIGURE

8-4 Shutdown Analysis

P

3

P

2

P

1

B

A

MC

AC

AVC

P

3

P

2

P

1

0

Quantity Supplied


The Competitive Firm’s Short-run

Supply Curve

●

Horizontal

 individual supply curves

 market supply curve

●

Method analogous to the construction of a market demand curve from individual demand curves.


FIGURE

8-5 Derivation of the

Industry Supply Curve s

$3.00

2.25 c e s

45 50

Quantity Supplied in

Thousands of Bushels

(a)

S

$3.00

2.25

C

E

S

45 50

Quantity Supplied in

Millions of Bushels

(b)


The Competitive Industry

● The Competitive Industry’s Short-Run

Supply Curve

♦

A competitive industry has a stable equilibrium at the output where supply equals demand.

♦

The competitive industry (unlike the competitive firm) faces a downward sloping demand curve.


FIGURE

8-6 Supply-Demand

Equil. of a Competitive Industry

S

D

$3.75

3.00

2.25

C

E

A

D

S

0 45 50

Quantity of Corn in


72



●

Industry Equilibrium in the Short Run

♦

Economic costs include opportunity costs, so zero economic profit means that firms are earning the normal, economy-wide rate of profit.

♦

Freedom of entry and exit guarantee this result in the long run under perfect competition.



●

Industry and Firm Equilibrium in the Long

Run

♦

In the long run, firms enter or exit the industry in response to profits or losses.

♦

This shifts the supply curve and the price until profits are zero.

♦

In long-run, competitive equilibrium, P = MC =

AC.


FIGURE

8-7 A Shift in the Industry

Supply Curve

$3.00

2.25

D

S

0

(1,000 firms)

S

0

(1,600 firms)

S

1

E

A

F

S

1

D

50 72



80


FIGURE

8-8 The Competitive Firm and the Competitive Industry

$3.00

2.25

Firm

MC

AC a e b

40 45 50



(a)

D

0

D

1

$3.00

2.25

D

S

0

Industry

(1,000 firms)

S

0

(1,600 firms)

S

1

E

A

D

S

1

50



(b)

72


FIGURE

8-9 L-R Equilibrium of the

Competitive Firm and Industry

Industry Firm

MC

D

AC

$1.87 m

40



(a)

D

2 $1.87

S

2



(b)

83

M

(2,075 firms)

S

2

D



●

The Long-Run Industry Supply Curve

■

The long-run supply curve of the competitive industry is also the industry’s long-run average cost curve.

■

The industry is driven to that supply curve by the entry or exit of firms and by the adjustment of firms already in the industry.


FIGURE

8-10 S-R Industry Supply and L-R Industry Average Cost

S

LRAC

B

$2.62

1.50

S

A

0 70

Output in

Millions of Bushels of Corn


Perfect Competition and

Economic Efficiency

●

In the long run, competitive firms are driven to produce at the minimum point of their average cost curves.

●

In this case, output is produced at the lowest possible cost to society.


TABLE

8-3 Avg. Cost for the Firm and Total Cost for the Industry


?

Which is Better to Cut

Pollution: Carrot or Stick?

●

The analysis of perfect competition can be used to show that, if firms are offered a subsidy to reduce their polluting emissions, the industry is likely to increase its emissions, because of free entry.


FIGURE

8-11 Taxes vs Subsidies as Incentives to Cut Pollution

T

X

S

D

B

E

A

T

X

S

D

0 Q b

Q e

Output

Q a


Chapter 10 THE FIRM AND THE INDUSTRY UNDER PERFECT

The Firm and the Industry

Under Perfect Competition

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Chapter 10 THE FIRM AND THE INDUSTRY UNDER PERFECT

The Firm and the Industry

Under Perfect Competition

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