ECON 211: Chp. 15 Perfect Competition

The Effects of Exit

- As firms exit, the market supply curve shifts leftwards - with the decrease in market supply, output decreases and market price rises - As the price rises, each firm that remains in the market move up along their supply curve and increase output - for each firm that remains, the profit-maximizing output increases - as the price rises and each firm sells more, economic loss decreases, each firm makes zero economic profit (normal profit) 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 .

price taker

- a firm that cannot influence the price of the good or service that it produces - the firm in perfect competition is a price taker (nothing makes a firm's product better than another firm's, all the same) - the producers of most agricultural products are price takers - perfectly elastic demand and there are perfect substitutes

Loss when producing

- a firm that 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 - if total revenue is less than total variable cost, the firm's economic loss will exceed total fixed cost

monopolistic competition

- a market in which a large number of firms compete by making similar but slightly different products - each firm is the sole producer of the particular version of the good in question - ex: Nike, Reebok, Asics, New Balance make their own version of the perfect shoe - each firm has a monopoly on a particular brand, but the firms compete with each other

oligopoly

- a market in which a small number of interdependent firms compete - might produce almost identical products (ex: Duracell vs Energizer) or they might produce differentiated products (ex: Coke vs Pepsi)

monopoly

- a market in which one firm sells a good or service that has no close substitutes and a barrier blocks the entry of new firms - ex: phone, gas, electricity, water suppliers, diamonds

Marginal Analysis and the Supply Decision

- another way to find the profit-maximizing output is to use marginal analysis which compares marginal revenue (MR) with marginal cost (MC) - as output increases, MR is constant but MC eventually increases - if MR>MC then revenue from selling one more unit exceeds the cost of producing that unit, increase in output increases economic profit - if MR<MC then the revenue from selling one more unit is less than the cost of producing that unit, decrease in output increases economic profit - if MR=MC then the revenue from selling one more unit equals the cost incurred to produce that unit. Economic profit is maximized and either an increase or decrease in output decreases economic profit

profit-maximizing output

- as output increases, total revenue increases, but total cost also increases - because of decreasing marginal returns, total cost eventually increases faster than total revenue - there is one output level that maximized economic profit, and a perfectly competitive firm chooses this output level - profit is maximized at the output level at which total revenue exceeds total cost by the largest amount

Entry and Exit

- entry and exit are the market forces that shift the supply curve and move the price to minimum average cost in the long run - in the short run, firms might make a positive economic profit or incur economic loss - but in the long run, firms make zero economic profit - entry and exit influence the market price, the quantity produced, and economic profit - immediate effect to enter or exit a market is to shift the market supply curve - if more firms enter a market, supply increases and shifts to right - if some firms exit a market, supply decreases and shifts to left

Loss when shut down

- if the firms shuts down temporarily, it receives no revenue and incurs no variable costs - the firm still incurs fixed costs - so if firm shuts down, it incurs an economic loss equal to total fixed cost - this loss is the largest that a firm need incur

The Shutdown Point

- if total revenue is less than total variable cost, a firm shuts down temporarily and limits its loss to an amount equal to total fixed cost - if total revenue equals total variable cost, a firm is indifferent between producing and shutting down - this situation arises when price equals minimum average variable cost and the firm produces the quantity at which average variable cost is a minimum

The Effects of Entry

- market output increases, but price falls - as price falls, each firm's economic profit decreases 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.

Is Perfect Competition Efficient?

- perfect competition is efficient - resources are used efficiently, marginal benefit equals marginal cost - the price equals marginal benefit and marginal cost, and the equilibrium quantity is efficient (P=MB=MC)

marginal revenue

- the change in total revenue that results from a one-unit increase in the quantity sold In perfect competition, marginal revenue equals price: - the reason is that the firm can sell any quantity it chooses at the going market price

Graph for price taker

- the demand curve is horizontal at the market price - price equals the marginal revenue, so the demand curve equals the marginal revenue curve - total revenue curve shows the total revenue at each quantity sold - the total revenue curve is an upward sloping straight line

Is Perfect Competition Fair?

- there are two view of fairness: fair rules and fair results - the outcome is fair in the rules view if property rights are enforced and people acquire resources, goods, and services through voluntary exchange - the outcome is fair in the results view if the poorest aren't too poor and the richest aren't too rich, but there is no unique criterion for determining what is too poor or too rich - in the short run, if a temporary shortage occurs in a competitive market (ex: natural disaster) the price shoots upward. In such situations, some might make large windfall gains that others. In the fair results view, perfect competition might be unfair. - But perfect competition in the long run seems to be fair on both views of fairness. It places no restrictions on anyone's actions, all trade is voluntary, consumers pay the lowest possible prices, and entrepreneurs earn only normal profit.

perfect competition

Perfect competition exists when: - many firms sell an identical product to many buyers - there are no barriers to entry into or exit from the market (free entry and exit) - established firms have no advantage over new firms - sellers are well informed about prices These condition arises when the market demand for the product is large relative to the output of a single producer. - a large market and the absence of economies of scale are not sufficient to create perfect competition, each firm must also produce a good or service that has no characteristics that are unique to that firm so that consumers don't care which to buy from. - all firms look the same to the buyer

Temporary Shutdown Decision

Sometimes, the price falls so low that a firm cannot cover its costs: what does the firm do in such situation? - answer depends on whether the firm expects the low price to be temporary or permanent - if temporary: firm remains in the market, but it might temporarily shut down. To decide whether to produce or to shut down, the firm compares the loss it would incur in the two situations - if permanent: firm exits the market

Market Types

The four market types are: - perfect competition - monopoly - monopolistic competition - oligopoly