Unit 4: Perfect Competition

Perfect Competition Characteristics

-Large number of sellers -Standardized product -Price takers -Easy entry and exit

Long run equilibrium for perfectly competitive firm

There is no incentive for entry or exit so zero economic profit achieve productive efficiency and allocative efficiency

Increasing Cost Industry

-LRSC slopes upward -The cost of production rises with expanded output

Long run Supply curve

A supply curve that represents the long run relationship between price and quantity supplied

Short Run Supply curve

A supply curve that represents the short run relationship between price and quantity supplied for a perfectly competitive firm, the portion of marginal cost curve that is at or above the minimum point of the AVC

Discuss the characteristics of perfect competition: Easy to enter and exit

Agriculture and foreign exchange markets are good examples of perfectly competitive industries

What if the price is lower than P1?

At Q2 there is no EP TR is NOT greater than TC P2 is at level of ATC when maximizing (MR=MC)

Will the market supply curve continue to expand beyond S2 (where supply curve shifted when profits incentivized entry )

At S2 there were no profits incentivizing firms to enter so we would not expect more firms to enter IF they did the market supply would shift right again which would reduce MR for each firm and would now be making a loss (OVER EXPANSION)

Demand increase in Short Run perfectly competitive markets

D INCR= MR Incr= Price Incr Leads to Incr in quantity a firm is able to produce

In perfect competition there is an identity that does not occur in other market models:

Identity occurs at constant price TR= (PxQ), MR reflects the change in TR as each additional unit is produced or sold and AR is TR divided by number of units sold P=MR=AR, so curve for MR is DEMAND CURVE due to constant price, MR=P=AR. This demand curve would graph as a horizontal line at the equilibrium or market price (MP) IT would only change when something occurs in the overall market to alter the market price

What would be the shape of the average revenue curve be

In a perfectly competitive situation, the AR will be equal to the MR marginal values drive averages. IF the marginal is always the same the average will not change

Curves if Profit Increase

Incr Entry --> Supply curve shift RIGHT Right Supply curve --> Price DECR P Decr---> MR decrease for individual firm

2 other industry types

Increasing- Cost Industry Decreasing cost industry

Decreasing Cost Industry

LRSC slopes upward the cost of production falls with expanded output

One firm's market for the product

MR=D is always horizontal at same price

Short Run Operations: In perfectly competitive firms produce until

MR=MR short of this quantity leaves additional production undone where R>C Beyond: R<C

QQ: In the short run, a perfectly competitive firm calculates the profit maximizing (or less minimizing) production output by equating

Marginal revenue and Marginal Cost

Discuss the characteristics of perfect competition: Standardized Products

Sellers in perfectly competitive markets all sell identical standard products. there is no difference in quality btw producers. There products may be graded i.e. #3 potato

What if price lowers to P3 in short run in perfectly competitive market?

Operating at a loss -seek to max profit at MR=MC or Q3 -@ Q3 each unit cost the ATC on the vertical axis - C>R -loss= Q3 x Vertical distance btwn (ATC and P3) In short run enough rev to cover variable cost -stay in operation -create enough for day to day -Once unable to change cost then shut down

QQ: Which of the following statements does not describe a perfectly competitive market? a) A large number of firms b)Entry and exit are easy c) In the short run firms can earn profits, minimize losses, or earn a normal profit d) Price is greater than marginal revenue

Price is greater than marginal revenue

What if price lowers to P3 in short run in perfectly competitive market

Price lower than p3 is below bother ATC and AVC -seek to max at MC=MR at Q4 -C>R -Loss=Q4 x Vertical distance btwn ATC and P4 In short run, not enough revenue is being produced to cover fixed and variable cost -SHUT DOWN and incur only fixed cost already took on

What is true in a perfectly competitive situation

Price=MR=AV

Compare and Contrast economic profit and normal profit

Profits are calculated by subtracting all of the firm's costs from total revenue (TR)-TC Economic profit is often called pure profits. It is the profit a firm received after paying all opportunity costs of production--Implicit and explicit If the firm has profits GREATER than ZERO it is earning an economic profit If the firm has zero economic profit after paying all costs of production, it is earning a NORMAL PROFITS If the firm has profits less than zero it has a loss

Discuss the characteristics of perfect competition: Price Takers

Since no single seller can influence the market the sellers in this market are price takers they can sell all they want at the equilibrium price but there is no market at a higher or lower price

Define total revenue, marginal revenue, and average revenue. Discuss why the demand curve is represented by the marginal revenue curve. Discuss how the equilibrium price is determined for an individual seller and how that price can be altered

TR= Price x Quantity MR= extra or additional reve that results from the production and sale of another unit of a product Average revenue is equal to Price; it is total revenue divided by number of units of output In a perfectly competitive market, individual sellers are price takers. Thus an individual seller's actions do not impact the equilibrium price To determine equilibrium price all sellers and buyer in the market produce a total demand and a total supply curve. Where they intersect find equilibrium price for overall market. For equilibrium price to change something in the overall market must change-- either a change in demand or supply occurs, or both.. the results of these changes will produce a new equilibrium price either higher or lower than previous. In this model, all additional sales of the product occur at the equilibrium price. The seller does not have to cut the price to sell more (constant price)

Marginal Revenue

The change in a firm's total revenue that results from a 1 unit change in output produced and sold

QQ: In the short run, if ATC is greater than price at the output level where MC=MR then:

The firm may be able to minimize losses

QQ: In the long run, if ATC equals price at the output level where MC=MR then:

The firm will earn a normal profit

Economic Profit

The level of profit that occurs when total revenue is greater than total cost

QQ: which of the following statements describes a perfectly competitive market under conditions of constant cost

The market supply curve becomes perfectly elastic in the long run

Short run supply curve for a perfectly competitive firm

The portion of the MC curve that is at or above the minimum point on the AVC curve is the short run supply curve

Discuss the characteristics of perfect competition: (Large number of sellers)

There are many sellers when the number of sellers is very large then no single seller can influence the market

QQ: In the long run, perfectly competitive firms achieve

allocative and productive efficiency

Constant- Cost industry

an industry in which the firms cost structures do not vary with changes in production

Losses incentivize exit

as firms eventually exit the market the supply curve shifts left Loss--> exit---> Supply curve shift LEFT

Profits Incentivize entry

as more firms enter the market the supply curve shifts to the right

QQ: Which of the following statements describes what perfectly competitive firms experience in the long run?

price equals the minimum point on ATC

Allocative efficiency

produce the good or services that are most wanted by consumers in such a way that MB=MC. Producer and consumer surplus is maximized

Where does short run supply curve start

begins at the shutdown point where a firm will not produce at a price lower than P(shutdown) or at the minimum AVC

QQ: A perfectly competitive firm

can sell as much output as it wants at the equilibrium price

QQ: Assume the corporation is producing 40 units of output and selling the output in a perfectly competitive market for $5 per unit. Its total fixed costs are $110 and its AVC is $4 for each of the 40 units of output. The corporation:

earns a loss of $70

Price Takers

firms that take or accept the market price and have no ability to influence that price each individual firm is a price taker

QQ: Price for a perfectly competitive seller equals

marginal revenue

The long run supply curve is

perfectly elastic

Productive efficiency

production takes place at the minimum ATC using the fewest resources possible to produce a good or service

Average Revenue

revenue per unit sold, equal to total revenue divided by the quantity of output produced and sold

QQ: A perfectly competitive firm's short run supply curve is at its lowest point when MC equals the minimum point of:

the average variable cost curve

Shut down point

the price below which a firm will choose not to operate in the short-run numerically this point occurs when MR=MC at the minimum average variable cost Graphically, this point occurs where price or MR intersects the MC at the minimum point of the average variable cost curve

QQ: In a perfectly competitive industry firms seek to maximize

total profit

Increased Market Supply

with increased market supply price drops The lower price reduces the marginal revenue for the individual firm