Chapter 12 - Perfect Competition and Supply Curve
Market price in relation to profit
Whenever the market price exceeds minimum average total cost, the producer is profitable. Whenever the market price equals minimum average total cost, the producer breaks even. Whenever the market price is less than minimum average total cost, the producer is unprofitable.
Profit Equations
Profit = TR - TC = (TR/Q - TC/Q) x Q = (P - ATC) x Q
The Long-Run Industry Supply Curve
There IS entry and exit
Profit
total revenue minus total cost Profit = TR - TC
In the long run, firms will exit an industry if
Firms will exit an industry if the market price is consistently less than their break-even price—their minimum average total cost.
Price taking firm's profit maximizing quantity of output graph Chapter 12.2
Note that whenever a firm is a price-taker, its marginal revenue curve is a horizontal line at the market price: it can sell as much as it likes at the market price. Regardless of whether it sells more or less, the market price is unaffected. In effect, the individual firm faces a horizontal, perfectly elastic demand curve for its output—an individual demand curve for its output that is equivalent to its marginal revenue curve. The marginal cost curve crosses the marginal revenue curve at point E where MC = MR
Entry
The arrival of new firms into an industry
Marginal Revenue
The change in total revenue generated by an additional unit of output Change in total revenue / Change in quantity of output =Delta TR/ Delta Q
Exit
The departure of firms from an industry
When price is greater than minimum average variable cost
The firm should produce in the short run In this case, the firm maximizes profit—or minimizes loss—by choosing the output quantity at which its marginal cost is equal to the market price
Minimum average total cost
The firm's "break even" price
Market share
The fraction of the total industry output accounted for by that producer's output
price-taking firm's optimal output rule
a price-taking firm's profit is maximized by producing the quantity of output at which the market price is equal to the marginal cost of the last unit produced P = MC at the price-taking firm's optimal quantity of output
zero economic profit
neither a profit nor a loss, earning only the opportunity cost of the resources used in production
If the market price is less than minimum average total cost:
there is no output level at which price exceeds average total cost. As a result, the firm will be unprofitable at any quantity of output
The Cost of Production and Efficiency in Long-Run Equilibrium
1) in a perfectly competitive industry in equilibrium, the value of marginal cost is the same for all firms.That's because all firms produce the quantity of output at which marginal cost equals the market price, and as price-takers they all face the same market price. 2) in a perfectly competitive industry with free entry and exit, each firm will have zero economic profit in long-run equilibrium. Each firm produces the quantity of output that minimizes its average total cost. Total cost of production of the industry's output is minimized in a perfectly competitive industry. 3) the long-run market equilibrium of a perfectly competitive industry is efficient: no mutually beneficial transactions go unexploited. Costs are minimized and no resources are wasted. Allocation of goods to consumers is efficient: every consumer willing to pay the cost of producing a unit of the good gets it.
Two necessary conditions for perfect competition
1) it must have many producers, none of whom have a large market share 2) the industry output is a standardized product - if consumers regard the products of all producers as equivalent
Price Taking Consumer
A consumer who cannot influence the market price of the good or service by his or her actions Market price is unaffected by how much or how little of the good the consumer buys
Economic and accounting relationship
A firm can make positive accounting profit while making zero or negative economic profit
Price Taking Producers
A producer is a price tacker when its actions cannot affect the market price of the good or service it sells Price taking producer considers the market price as given
Standardized product Also known as commodity
A product that consumers regard as the same good even when it comes from different producers
Perfectly competitive market
All market participants (both consumers and producers) are price takers Neither consumption decisions by individual consumers nor production decisions by individual producers affect the market price of the good
Perfectly competitive industry
An industry in which producers are price takers
Profit in relation to the break even price
At break even point - zero profit market price is above the break-even price -positive profit market is below break even price - negative profit (suffers a loss)
Accounting profit
Calculated using only explicit costs incurred by the firm Does not incorporate the opportunity cost of resources owned by the firm and used in the production of output
Using the relationship of P and ATC to determine if a firm is profitable or not
If the firm produces a quantity at which P > ATC, the firm is profitable. If the firm produces a quantity at which P = ATC, the firm breaks even. If the firm produces a quantity at which P < ATC, the firm incurs a loss.
Using the relationship of TR and TC to determine if a firm is profitable or not
If the firm produces a quantity at which TR > TC, the firm is profitable. If the firm produces a quantity at which TR = TC, the firm breaks even. If the firm produces a quantity at which TR < TC, the firm incurs a loss.
Free Entry and Exit
Perfectly competitive industries have free entry and exit. It is easy for new firms to enter the industry or for firms that are currently in the industry to leave No obstacles in the form of government regulations or limited access to key resources prevent new producers from entering the market No additional cost associated w shutting down a company and leaving the industry Not strictly for perfect competition
Profit per unit of output
Profit / Q = (TR/Q) - (TC/Q) Where: TR/Q is average revenue (which is the market price) TC is average total cost
Optimal output rule
Profit is maximized by producing the quantity of output at which the marginal revenue of the last unit produced is equal to its marginal cost MR = MC at the optimal quantity of output
long-run industry supply curve
Shows how the quantity supplied responds to the price once producers have had time to enter or exit the industry. The line that passes though the intersection points
Economic profit
The measure of profit based on the opportunity cost of resources used in the business Firm's total cost incorporates the implicit cost and the explicit cost in the forms of benefits forgone and actual cash outlays Economic profit incorporates the opportunity cost of resources owned by the firm and used in the production of output A firm's decision to produce/ not or to stay in business / close down should be determined based on economic profit
break-even price
The minimum average total cost of a price-taking firm the price at which it earns zero profit
Shut down price
The price at which the firm ceases production in the short run
When the market price is below minimum average variable cost:
The price the firm receives per unit is not covering its variable cost per unit. A firm in this situation should cease production immediately. Why? Because there is no level of output at which the firm's total revenue covers its variable costs—the costs it can avoid by not operating. The firm maximized profit by not producing at all - minimizing the losses Minimum average variable cost is equal to the shut down price
What will happen as additional producers enter the industry?
The quantity supplied at any given price will increase. The short-run industry supply curve will shift to the right. This will, in turn, alter the market equilibrium and result in a lower market price. Existing firms will respond to the lower market price by reducing their output The total industry output will increase because of the larger number of firms in the industry.
long-run industry supply curve is always flatter than the short-run industry supply curve.
The reason is entry and exit: a high price caused by an increase in demand attracts entry by new producers, resulting in a rise in industry output and an eventual fall in price; a low price caused by a decrease in demand induces existing firms to exit, leading to a fall in industry output and an eventual increase in price.
In the short run, the firm should produce even if price falls below minimum average total cost
The reason is that total cost includes fixed cost—cost that does not depend on the amount of output produced and can only be altered in the long run In the short run, fixed cost must still be paid, regardless of whether or not a firm produces Although fixed cost should play no role in the decision about whether to produce in the short run, other costs—variable costs—do matter
When the marginal cost curve is falling at first before rising
The short run average variable cost curve is U shaped the initial fall in marginal cost causes average variable cost to fall as well, before rising marginal cost eventually pulls it up again
When the long run industry supply curve is sloped downward
This can occur when an industry faces increasing returns to scale, in which average costs fall as output rises
Variable Costs
Variable costs can be saved by not producing; so they should play a role in determining whether or not to produce in the short run Ex of Variable Cost: the wages of workers who must be hired to help with planting and harvesting
long-run market equilibrium
a situation in which the quantity supplied equals the quantity demanded given that sufficient time has elapsed for producers to either enter or exit the industry. All existing and potential producers have fully adjusted to their optimal long-run choices; as a result, no producer has an incentive to either enter or exit the industry.
This means that whenever price lies between minimum average total cost and minimum average variable cost, the firm is better off producing some output in the short run
by producing, it can cover its variable cost per unit and at least some of its fixed cost, even though it is incurring a loss.
constant costs across the industry:
each firm, regardless of whether it is an incumbent or a new entrant, faces the same cost structure (that is, they each have the same cost curves). Industries that satisfy this condition are industries in which there is a perfectly elastic supply of inputs Ex: industries like agriculture and bakeries Result - horizontal line
The Short-Run Industry Supply Curve
in the short run the number of producers in an industry is fixed There is NO entry or exit shows how the quantity supplied by an industry depends on the market price given a fixed number of producers. The short-run industry supply curve, S, is the industry supply curve taking the number of producers—here, 100—as given. It is generated by adding together the individual supply curves of the 100 producers. Below the shut-down price of $10, no producer wants to produce in the short run. Above $10, the short-run industry supply curve slopes upward, as each producer increases output as price increases. It intersects the demand curve, D, at point EMKT, the point of short-run market equilibrium, corresponding to a market price of $18 and a quantity of 5,000 trees
Total Revenue
is equal to price multiplied by quantity of output TR = P x Q
short-run individual supply curve
shows how an individual producer's profit-maximizing output quantity depends on the market price, taking fixed cost as given.
industry supply curve
shows the relationship between the price of a good and the total output of the industry as a whole
Increasing costs across the industry
the long-run industry supply curve slopes upward. The usual reason for this is that producers must use some input that is in limited supply (that is, inelastically supplied). As the industry expands, the price of that input is driven up. Consequently, later entrants in the industry find that they have a higher cost structure than early entrants.
Whenever there is free entry and exit
the long-run price elasticity of supply is higher than the short-run price elasticity
Whenever the market price exceeds minimum average total cost:
the producer can find some output level for which the average total cost is less than the market price. In other words, the producer can find a level of output at which the firm makes a profit.
short-run market equilibrium
the quantity supplied equals the quantity demanded, taking the number of producers as given