Chapter 15: Prefect Competition

Economic Loss in the Short Run

price < ATC economic loss = loss per can x # of cans sold = red rectangle

short-run equilibrium causes three possible situations: #1— normal profit / zero economic profit #2 economic profit #3 economic loss

#1 ATC = Market Price = zero economic profit = normal profit #2 ATC < Market Price = economic profit #3 ATC > Market Price = economic loss

ways to find Profit-Maximizing Output

#1— use a firm's total revenue and total cost curves #2— use marginal analysis

A decrease in demand triggers a similar response, except in the opposite direction. The decrease in demand brings a lower price, economic loss, and exit. Exit decreases market supply, raises the price, and eliminates the economic loss.

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shows the supply curve for the competitive syrup market. In this example, the market consists of 10,000 firms exactly like Dave's Maple Syrup. The table shows how the market supply schedule is constructed. The shutdown point occurs at a price of $3 a can. At prices below $3 a can, every firm in the market shuts down; the quantity supplied is zero.

At a price of $3 a can, each firm is indifferent between shutting down (producing nothing) or operating and producing 7 cans of syrup a day. The quantity supplied by each firm is either 0 or 7 cans of syrup a day, and the quantity supplied in the market is between 0 (all firms shut down) and 70,000 cans (all firms produce 7 cans a day each). At prices above $3 a can, we sum the quantities supplied by the 10,000 firms, so the quantity supplied in the market is 10,000 times the quantity supplied by one firm.

OUTPUT, PRICE, AND PROFIT IN THE LONG RUN

Competitive markets are in a constant state of change—— Price, quantity, and economic profit fluctuate as demand and supply change all 3 situations are temporary in prefect competition

permanent increase in demand increases the number of firms

Each firm produces the same output in the new long-run equilibrium as initially and makes zero economic profit. In the process of moving from the initial equilibrium to the new one, firms make economic profit.

Effects of entry Initially ——— surge of popularity == increases demand == demand curve shifts upward == price rises = market output increases = economic profit increase in demand raises the price entry increases supply and lowers the price

Eventually ——— with greater market supply + unchanged demand == price falls + equilibrium qaunityt increase ==Market output increase, but BC prices fell, producers output decreases == price falls == firms gradually return to their normal output == ** market as a whole still produces more due to the increased new of suppliers within the market = each firm;s eocnomic profit decrease == prices falls to MP ==> zero eocnomic profit again entry process stops, and the market is again in long-run equilibrium.

In the short run, -- a firm achieves its objective of maximizing economic profit by deciding the quantity to produce. This quantity influences the firm's total revenue, total cost, and economic profit. *** price-taker ** doesn't influence prices

In the long run, a firm achieves its objective of maximizing economic profit by deciding whether to enter or exit a market.

in short-run= firms make either economic loss or profit in long-run= firms make zero economic profit

In the long run, firms respond to economic profit and loss by either entering or exiting a market profit = new firms enter market loss= some existing firms exit market

economic profit = incentive to firms --> more firms enter the market ---> market supply increase + market price falls --> with lower prices ---> firms decrease output to keep MC equal to the price --> market eventually returns to long-term equilibrium + zero economic profit

Key difference between the initial long-run equilibrium and the new long-run equilibrium? **** the number of firms

Loss When Shut Down— If the firm shuts down temporarily, it receives no revenue and incurs no variable costs. The firm still incurs fixed costs. So, if a firm shuts down, it incurs an economic loss equal to total fixed cost. This loss is the largest that a firm need incur.

Loss When Producing— produces an output receives revenue and incurs both fixed costs and variable costs. The firm incurs an economic loss equal to total fixed cost plus total variable cost minus total revenue. If total revenue exceeds total variable cost, the firm's economic loss is less than total fixed cost. But if total revenue is less than total variable cost, the firm's economic loss will exceed total fixed cost.

Marginal Analysis

MR > MC -- increase in output = increase in economic profit MR < MC -- decrease in output = increase in economic profit MR =MC -- either increase or decrease in output = decrease in economic profit

Perfect competition exists when... arise when the market demand for the product is large relative to the output of a single producer - economies of scale are absent But a large market and the absence of economies of scale are not sufficient to create perfect competition***

Many firms sell an identical product to many buyers. (no unqiness) There are no barriers to entry into (or exit from) the market. Established firms have no advantage over new firms. Sellers and buyers are well informed about prices.

Positive Economic Profit in the Short Run

Market demand might be greater or less than Qd and the price might be higher or lower than MP - makes an economic profit = (differnce from MP - Price used) x quantity sold =>> area of the rectangle (height×length)(height×length) price > ATC = blue rectangle

Monopolistic competition — a market in which a large number of firms compete by making similar but slightly different products

Oliopogly— a market in which small number of interdependent firms compete

The four market types are...

Perfect competition Monopoly Monopolistic competition Oligopoly

Is Perfect Competition Fair? fair rules view + fair-result view

Perfect competition places no restrictions on anyone's actions, all trade is voluntary, consumers pay the lowest possible prices, and entrepreneurs earn only normal profit. But price hikes arising from shortages following a natural disaster might be exceptions. In such situations, large windfall gains for a few and high prices for essential items for many might be regarded as an unfair result. If it is considered unfair, it must be compared with the fairness of an alternative mechanism for allocating scarce resources.

Is Perfect Competition Efficient? YES An efficient outcome is one in which scarce resources are allocated to their highest-value use. Perfect competition is efficient.

Resources are used efficiently when it is not possible to get more of one good without giving up something that is valued more highly. efficient BC— - marginal benefit = marginal cost - total surplus (consumer surplus plus producer surplus) is maximized -equilibrium quantity is efficient = D-curve and S-curve intersect at equilibrium price and quantity

Spply curve = MC curve in PC The supply curve is the marginal cost curve at all points above the minimum of average variable cost (the shutdown price). Because the market supply curve is found by summing the quantities supplied by all the firms at each price, the market supply curve is the entire market's marginal cost curve.

The market demand curve is the marginal benefit curve. Because the market supply curve and market demand curve intersect at the equilibrium price, that price equals both marginal cost and marginal benefit.

Market Supply in the Short Run ***Market supply is perfectly elastic at the price at which the shutdown point occurs. below MP == market supply curve runs along the vertical axis (perfectly inelastic) At MP == perfectly elastic Above MP = upwards sloping

The quantity supplied at a given price is the sum of the quantities supplied by all firms at that price.

price taker — a firm that cannot influence the price of the good or service that it produces **most agricultural products are price takers (maple syrup/ wheat farming) MR = Price + constant rate

You can't get a higher price than $4, and you have no incentive to offer it for less than $4 because you can sell your entire output at that price. no incentive to sell it higher BC no demand for higher prices due to competitive pricing

Entry and Exit .... prospect of persistent economic profit or economic loss trigger entry or exit — NOT Temporary economic profit or loss

are the market forces that shift the supply curve and move the price to minimum average total cost in the long run

Profit-Maximizing Output Profit is maximized at the output level where TR > TC by the largest amount ***profit curve is at its highest when the vertical distance between the TR and TC curves is greatest.

as output increase == Total Revenue + Total Cost increases Due to Decreasing marginal returns == TC eventually increases faster than TR

examples of Perfect competition Wheat farming, fishing, wood pulping and paper milling, the suppliers of coffee and snacks, travel website, lawn service, dry cleaning, and the provision of laundry services

examples of Monopolies phone, gas, electricity, and water suppliers are local monopolies—monopolies that are restricted to a given location (DeBeers/ Microsoft)

examples of Monopolistic competition market for running shoes, Nike, Reebok, Fila, Asics, New Balance, and many others make their own versions of the perfect shoe --reminds us that each firm has a monopoly on a particular brand of shoe but the firms compete with each other.

examples of Oligpoly - Airplane manufacture - produce almost identical products, such as Duracell and Energizer batteries - produce differentiated products, such as the colas produced by Coke and Pepsi

Temporary Shutdown Decision depends on whether the firm expects the low price to be permanent or temporary

firm exits the market = incurs an economic loss that it believes is permanent and sees no prospect of ending Decide whether to stay or leave based comparing the loss it would incur in 2 situations = incurs an economic loss that it believes is temporary, it remains in the market, but it might temporarily shut down

Technological Change -- price falls until ALL firms use new technology and economic profit is zero these lower prices + better products are permeant gains for consumers

firms adopt new technologies BC new technologies lower cost with lower costs == supply increases + price falls Firms w/ new tech = economic profit + enter market Firms w/ old tech = economic loss + exit market

profit-maximizing output is its quantity supplied law of supply

if price were higher than price of quantity supplied than increase production if price were lower than price of quantity supplied than decrease production

the market demand curve is D. With this market demand, the price equals minimum average total cost only if the market supply curve is S. If supply is less than S (the supply curve is to the left of S), the price is above $5 a can;..

if supply exceeds S (the supply curve is to the right of S), the price is below $5 a can. Market forces operate to shift the supply curve back to S, and the arrows pointing toward S represent these forces.

The Shutdown Point— The point at which price equals minimum average variable costs and the quantity produced is that at which average year will cost is at its minimum Price = Minimum AVC Price < AVC == shut-sown and produces no output

if the price is above minimum average variable cost, Dave maximizes profit by producing the output at which marginal cost equals marginal revenue, which also equals price. If price equals minimum average variable cost, Dave maximizes profit (minimizes loss) by either producing the quantity at the shutdown point or shutting down and producing no output. But if the price is below minimum average variable cost, Dave shuts down and produces no output.

Entry and exit influence the... - market price - quantity produced - economic profit

immediate effect of the decision to enter or exit a market is to shift the market supply curve. more firms enter = supply increases ==> market supply curve shifts rightward some firms exit = supply decreases ==> market supply curve shift leftward

Economic loss is an incentive for firms to exit a market, but as they do so, the price rises and the economic loss of each remaining firm decreases.

key proposition

Economic profit is an incentive for new firms to enter a market, but as they do so, the price falls and the economic profit of each existing firm decreases.

key proposition

Perfect competition— a market in which there are many firms, each selling an identical product; Many buyers; No bears entry of new firms into the industry; No advantage to established firm; And buyers and sellers are well informed about prices

monopoly— a market in which one firm sells a good or service that has no close substitute in a barrier blocks the entry of new firms

Change in Demand

results in.. - Market price rising - firms increase production to keep MC equal to the price - firms now make an economic-profit (sways aways from long-term equilibruim)

The Effects of Exit

starting in long-rum equilibruim... - a decrease in demand shifts market demand curve downward == prices falls below MP = economic losses inccur = firms exit - as firms exit, market supply curve shifts leftward== equilbrium price rises to MP == quantity produced decrease

Market forces operate to compete away economic profits and eliminate economic losses to move the price toward the lowest possible price ===>> Price = Minimum ATC = zero profit

the firm earns zero economic profit, but firm's entrepreneur earns normal profit—part of the firm's total costs Price above ATC = supply increases and price falls Price below ATC = supply decreases and price rises

Marginal Analysis and the Supply Decision

use marginal analysis, which compares marginal revenue, MR, with marginal cost, MC as output increase, MR is constant, but as MC eventually increases

Explain a perfectly competitive firm's profit-maximizing choices and derive its supply curve.

• A perfectly competitive firm is a price taker. • Marginal revenue equals price. • The firm produces the output at which price equals marginal cost. • If price is less than minimum average variable cost, the firm temporarily shuts down. • A firm's supply curve is the upward-sloping part of its marginal cost curve at all prices at or above minimum average variable cost (the shutdown point) and the vertical axis at all prices below minimum average variable cost.

Explain how output, price, and profit are determined in the long run

• Economic profit induces entry, which increases market supply and lowers price and profit. Economic loss induces exit, which decreases market supply, raises price, and lowers the losses. • In the long run, economic profit is zero and there is no entry or exit. • An increase in demand increases the number of firms and increases the equilibrium quantity. • An advance in technology that lowers the cost of producing a good increases market supply, lowers the price, and increases the quantity.

Explain how output, price, and profit are determined in the short run.

• Market demand and market supply determine the price. • Firms choose the quantity to produce that maximizes profit, which is the quantity at which marginal cost equals price. • In short-run equilibrium, a firm can make a positive economic profit, make zero economic profit, or incur an economic loss.

explain why perfect competition is efficient

• Perfect competition is efficient because it makes marginal benefit equal marginal cost, and it is fair because trade is voluntary, consumers pay the lowest possible prices, and entrepreneurs earn normal profit.