C h a p t e r eleven © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando & Yvonn

c h a p t e rc h a p t e r

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© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed.

Prepared by: Fernando & Yvonn Quijano

Firms in Perfectly Competitive Markets

2 of 35© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed.

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tsFirms in Perfectly Competitive Markets

MARKET STRUCTURE

CHARACTERISTICPERFECT COMPETITION

MONOPOLISTIC COMPETITION OLIGOPOLY MONOPOLY

Number of firms

Type of product

Ease of entry

Examples of industries

Many

Identical

High

• Wheat• Apples

Many

Differentiated

High

• Selling DVDs• Restaurants

Few

Identical or differentiated

Low

• Manufacturing computers• Manufacturing automobiles

One

Unique

Entry blocked

• First-class mail delivery• Tap water

The Four Market Structures

11 – 1


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LEARNING OBJECTIVE1

Perfectly competitive market A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, (3) no barriers to new firms entering the market.


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A Perfectly Competitive Firm Cannot Affect the Market Price

Price taker A buyer or seller that is unable to affect the market price.

11 - 1A Perfectly Competitive Firm Faces a Horizontal Demand Curve


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Perfectly Competitive Market

Profit Total revenue minus total cost.Profit = TR - TC

LEARNING OBJECTIVE2

11 - 2The Market Demand for Wheat versus the Demand or One Farmer’s Wheat

Don’t Confuse the Demand Curve for Farmer Douglas’s Wheat with the Market Demand Curve for Wheat


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Revenue for a Firm in a Perfectly Competitive Market

Average revenue (AR) Total revenue divided by the number of units sold.

Q

TRAR

or ,quantityin Change

revenue in total Change Revenue Marginal

Q

TRMR

PQ

QP

Q

TRAR

so,

Marginal revenue (MR) Change in total revenue from selling one more unit.


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Farmer Douglas’s Revenue from Wheat Farming

11 – 2

NUMBER OF BUSHELS

(Q)

MARKET PRICE

(PER BUSHEL)

(P)

TOTAL REVENUE

(TR)

AVERAGE REVENUE

(AR)

MARGINAL REVENUE

(MR)

0

1

2

3

4

5

6

7

8

9

10

$4

4

4

4

4

4

4

4

4

4

4

$0

4

8

12

16

20

24

28

32

36

40

-

$4

4

4

4

4

4

4

4

4

4

-

$4

4

4

4

4

4

4

4

4

4


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Perfectly Competitive MarketRevenue for a Firm in a Perfectly Competitive Market

Farmer Douglas’s Profits from Wheat Farming

11 –3

QUANTITY(BUSHELS)

(Q)

TOTALREVENUE

(TR)

TOTALCOSTS

(TC)

PROFIT

(TR-TC)

MARGINAL REVENUE

(MR)

MARGINAL COST

(MC)

0

1

2

3

4

5

6

7

8

9

10

$0.00

4.00

8.00

12.00

16.00

20.00

24.00

28.00

32.00

36.00

40.00

$1.00

4.00

6.00

7.50

9.50

12.00

15.00

19.50

25.50

32.50

40.50

-$1.00

0.00

2.00

4.50

6.50

8.00

9.00

8.50

6.50

3.50

-0.50

$4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

$3.00

2.00

1.50

2.00

2.50

3.00

4.50

6.00

7.00

8.00


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11 - 3The Profit-Maximizing Level of Output


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Profit = (P x Q) TC

Illustrating Profit or Losson the Cost Curve Graph

LEARNING OBJECTIVE3

Q

QP )(

Q

ProfitQ

TC

,Profit

ATCPQ

Profit = (P ATC)Q

Or


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Showing a Profit on the Graph11 - 4

The Area of Maximum Profit



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Illustrating When a Firm Is Breaking Even or Operating at a Loss P > ATC, which means the firm makes a profit P = ATC, which means the firm breaks even (its total cost equals it total revenue) P < ATC, which means the firm experiences losses

11 - 5

A Firm Breaking Even and Experiencing Losses



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to Shut Down in the Short Run

LEARNING OBJECTIVE4

In the short run a firm suffering losses has two choices:

Continue to produce

Stop production by shutting down temporarily

Sunk cost A cost that has already been paid and that cannot be recovered.


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The Supply Curve of the Firm in the Short Run

The Firm’s Short-Run Supply Curve11 - 6

Shutdown point The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.

Deciding Whether to Produceor to Shut Down in the Short Run


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The Entry and Exit of Firms in the Long Run

Economic Profit and the Entry or Exit Decision

Economic profit A firm’s revenues minus all its costs, implicit and explicit.

Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs.


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EXPLICIT COSTS

Water

Wages

Organic fertilizer

Electricity

Payment on bank loan

$25,000

$35,000

$14,000

$5,000

$6,000

IMPLICIT COSTS

Foregone salary

Opportunity cost of the $100,000 she has invested in her farm

Total Cost

$30,000

$10,000

$125,000

Farmer Appleseed’s Costs per Year

11 – 5


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Economic Profit and the Entry or Exit DecisionECONOMIC PROFIT LEADS TO ENTRY OF NEW FIRMS

11 - 8The Effect of Entry on Economic Profits


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ECONOMIC LOSSES LEAD TO EXIT OF FIRMS

11 - 9The Effect of Exit on Economic Losses


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Long-Run Equilibrium in a Perfectly Competitive Market

Long-run competitive equilibrium The situation in which the entry and exit of firms have resulted in the typical firm just breaking even.


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The Long-Run Supply Curve in a Perfectly Competitive Market

Long-run supply curve A curve showing the relationship in the long run between market price and the quantity supplied.


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LEARNING OBJECTIVE6

Productive Efficiency

Productive efficiency The situation in which a good or service is produced at the lowest possible cost.


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Allocative EfficiencyFirms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them:

The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold.

Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit.

Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.


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Allocative Efficiency

Allocative efficiency A state of the economy in which production reflects consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.


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Allocative efficiency

Average revenue (AR)

Economic loss

Economic profit

Long-run supply curve

Marginal revenue

Perfectly competitive market

Price takerProductive efficiencyProfitShutdown pointSunk cost

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C h a p t e r eleven © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando & Yvonn