Perfect Competition Wk-4

7/30/2019 Perfect Competition Wk-4

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Copyright 2008 The McGraw-Hill Companies9-1

Four MarketModelsPure CompetitionProfitMaximization inthe Short-RunMarginal Costand Short-RunSupplyChanges inSupplyProfitMaximization inthe Long RunSupplyReadjustmentPure Competitionand EfficiencyLong-RunEquilibriumLast Word

Key Terms

End Show

PureCompetition


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Four MarketModelsPure CompetitionProfitMaximization inthe Short-RunMarginal Costand Short-RunSupplyChanges in

SupplyProfitMaximization inthe Long RunSupplyReadjustmentPure Competitionand EfficiencyLong-Run

EquilibriumLast Word

Key Terms

End Show

Pure CompetitionCharacteristics of a

Perfectly CompetitiveMarket

1.Very Large Numbers2.Homogeneous Product3.Easy Entry and Exit

Examples of PerfectlyCompetitive Markets: Agriculture,Commodity Markets (Gold, Metals,

Corn, wheat), The Stock Market


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Four Market

ModelsPure CompetitionProfitMaximization inthe Short-RunMarginal Costand Short-RunSupplyChanges in



Key Terms

End Show

Perfectly Competitive Market

Supply and Demand set themarket price

40

30

20

15

10

MarketPrice

1 2 3 4 5 6 7 8

MarketSupply of

Wheat

MarketDemandfor Wheat

Marketfor Wheat

ChicagoMercantile

Exchange

Market Quantity

Millions of Bushels ofWheat

Buyers and Sellers are Price Takers in PerfectlyCompetitive Markets. Each buyer and seller is very smallrelative to the size of the market and therefore they have

no influence over the market price.


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Four Market




Key Terms

End Show

Profit Maximization in theShort Run

We assume the goal of the firm isto maximize profits

Profits =Total Revenue-Total Cost

Revenue = Price * Quantity

Total Cost discussed in

preceding chapters.


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Four Market




Key Terms

End Show

Profit MaximizationProfits = Revenues Total Costs

Total Product(Output) (Q) Total Cost

(TC)Total Revenue

= P * QProfit (+)

or Loss (-)

Price = $20

020406080

$100200600900

1400

$-100200200300200

0400800

12001600

Profits are Revenues - CostsRevenues = Price * QuantityMarket sets the price.The firm picks the quantity that maximizes profitsCosts are determined by wages and the cost of capital.

Price

2020202020

MaxProfits


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Four Market




Key Terms

End Show

How do firms find the profit maximizing

level of output?

Profit Maximization

Firms dont have the ability to see revenues

and costs for levels of output they are notproducing. Marginal Analysis: If we increase or

decrease output do profits go up or down?

Total Product(Output) (Q) Total Cost

(TC)Total Revenue

= P * QProfit (+)

or Loss (-)

Price = $20

020406080

$100200600900

1400

$-100200200300200

0400800

12001600

Price

2020202020

MaxProfits


7/23Copyright 2008 The McGraw-Hill Companies9-7

Four Market




Key Terms

End Show

The Demand and Marginal Revenue Curvesfor a Perfectly Competitive firm

40

30

20

15

10

MarketPrice

1 2 3 4 5 6 7 8

Market QuantityMillions of Bushels ofWheat

MarketSupply ofWheat

MarketDemandfor Wheat

Marketfor Wheat

ChicagoMercantile

Exchange

40

30

20

15

10

Price

20 40 60 80 100

MarketPrice = D =MR

Farmer inNebraska

Farmers

Quantity ofWheat

Market sets the price.

Firm can sell all they want at the market price Demand Curve for the firm is perfectly elastic at the marketprice. Marginal Revenue = Change Revenue/Change in Output =Market Price. Market Price = D = MR



Four Market




Key Terms

End Show

Costand

Revenu

e 30

20

10

20 40 60 80 100 120 140 160 180 200

Output

Marginal Revenue-Marginal Cost Approach

MR = MC Rule for maximizing profits

Profit Maximization

D = MR = P

MC

MR = MC



Four Market




Key Terms

End Show

Costand

Revenu

e 30

20

10

20 40 60 80 100 120 140 160 180 200

Output



Profit Maximization

D = MR = P

MC

ATC

To Calculate Profits followthese steps:

Step One: Find the output levelwhere MR = MC. Q = 100.

Step Four: Calculate the TotalCosts = ATC * Q = 15* 100 =$1,500.

Step Five: Calculate the Profits= Revenues Costs = $2000 -$1500 = $500.

Step Three: Find theATC at the profit maximizinglevel of output. ATC = 15.

Step Two: Calculate Revenues= Price * Quantity = 20 * 100 =$2,000

15

Output whereMR =MC

100



Four Market




Key Terms

End Show

Costand

Revenu

e 30

20

10

20 40 60 80 100 120 140 160 180 200

Output



Profit Maximization

D = MR = P

MC

ATC

To Calculate Profits followthese steps:

Step One: Find the output levelwhere MR = MC. Q = 100.

Step Four: Calculate the TotalCosts = ATC * Q = 25* 100 =$2,500.

Step Five: Calculate the Profits= Revenues Costs = $2000 -$2500 = -$500.

Step Three: Find theATC at the profit maximizinglevel of output. ATC = 25.

Step Two: Calculate Revenues= Price * Quantity = 20 * 100 =$2,000

25

Output whereMR =MC

100



Four Market




Key Terms

End Show

Economics Versus AccountingProfits and Costs

Accounting Profits = RevenuesExplicit Costs Economic Profits = Revenues

Explicit Cost Implicit Costs

EconomicProfit

AccountingProfit

ImplicitCost= -

Graphs show economicprofits. Cost include implicit

cost.



Four Market




Key Terms

End Show

Stay or Exit industry in the LongRun

Exit the industry in the long runifEconomic Profits < 0

Revenue Economic Cost < 0P * Q ATC * Q < 0

(P ATC) * Q < 0

P < ATC



Four Market




Key Terms

End Show

Shut down in the Short Run

Costs = $2500

Revenues = $2000 Losses = $500 Should the firm shut down in the short

run?

Suppose Fixed costs = $1000 andVariable Costs = $1500.

Firm will lose $1000 if they shut down,instead of $500.

Revenues Variable Cost = $2000 -$1500 = $500. The firm can use the $500 to pay some

fixed costs.



Four Market




Key Terms

End Show

Shut Down Points

Exit the industry in the short run

ifP < AVC

Stay open in the short run if

P > AVC

Stay open if Revenues Variable

Costs > 0P * Q > AVC * Q

P > AVC

M k t S t th P i f Market M k t L R



Four Market




Key Terms

End Show

C

ostand

Revenue 30

20

10

20 40 60 80 100 120 140 160 180 200

Output

D = MR = P

MC

ATC

Market Sets the Price forWheat

15

40

30

20

15

10

MarketPrice

1 2 3 4 5 6 7 8

Market Supplyof Wheat

MarketDemand forWheat

Marketfor Wheat

Market QuantityMillions of Bushels of Wheat

Farmer takes the price as givenand produces where MC= MR

Economic Profits = (P-ATC) * Q

= (20-11)*120 = 1080.

Economic Profits = AccountingProfits Implicit Costs.

Implicit Costs are the accountingprofits the firm could makeelsewhere. This firm is making$1080 more in account profitsthen firms elsewhere = > Entry.

Entry cause price to

fall to $15. But profitsare still positive (P-

ATC)*Q = $500

Entry occurs until P=ATCand Profits are maximizedMR = MC

Long RunEquilibrium for aPerfectlyCompetitive Firm



Four Market




Key Terms

End Show

C

ostand

Revenue 30

20

10

20 40 60 80 100 120 140 160 180 200

Output

D = MR = P

MC

ATC15

Long Run Equilibrium for aPerfectly Competitive Firm

Zero economic profits



Four Market




Key Terms

End Show

PureCompetition

Long RunSupply Curve

Market Market



Four Market




Key Terms

End Show

C

ostand

Revenue 30

20

10

20 40 60 80 100 120 140 160 180 200

Output

D = MR = P

MC

ATC

20

10

MarketPrice

1 2 3 4 5 6 7 8

Market Supply of Wheat

Demand for Wheat

Marketfor Wheat


D = MR = P

Demand for Wheat

Demandshifts downand profits go

back to zero

Market Supply of WheatConstant Costindustry.

As an industry

grows (demandincreases) ifthe costs staythe same thenit is a constantcost industry.


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Four Market




Key Terms

End Show

Long Run Supply Curve is Horizontal ina Constant Cost Industry

20

10

MarketPrice

1 2 3 4 5 6 7 8


Demand for

Wheat

Marketfor Wheat



Demand forWheat

Long RunSupply Curve

Short RunEquilibrium

Long RunEquilibrium

Long RunEquilibrium

As demandgrows profitsinitially rise.

But the increasein profits causesentry.

Supply Curveshifts out.

Long Run SupplyCurve is theSupply Curvethat connects theLR equilibrium

points on themarket supplyand demand.

Demand forWheat

Market Market


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Four Market




Key Terms

End Show

C

ostand

Revenue 30

20

15

10

20 40 60 80 100 120 140 160 180 200

Output

P =10

MC

ATC

20

10

MarketPrice

1 2 3 4 5 6 7 8

S

D1

Marketfor Wheat


P=20

P =15

S1

D

ATC1

Cost increaseas industrygrows

MC1

Long Run Supply Curve


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Four Market




Key Terms

End Show

Long Run Supply CurveIncreasing Cost Industry

20

15

10

MarketPrice

1 2 3 4 5 6 7 8


Marketfor Wheat



Demand for Wheat

Long Run SupplyCurve

Increasing CostIndustry


Long RunEquilibrium

Long RunEquilibrium






Demand for Wheat

Market Market


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Four Market




Key Terms

End Show

C

ostand

Revenue 30

20

10

7

20 40 60 80 100 120 140 160 180 200

Output

P =10

MC

ATC

20

10

7

MarketPrice

1 2 3 4 5 6 7 8

S

D1

Marketfor Wheat


P=20

P = 7

S1

D

ATC1

MC1

Cost Decreaseas industrygrows

Long Run Supply Curve


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C G C9 23

Four Market




Key Terms

End Show

Long Run Supply CurveDecreasing Cost Industry

20

15

10

7

MarketPrice

1 2 3 4 5 6 7 8


Marketfor Wheat


Market Supply

of Wheat

Demand for Wheat

Long Run SupplyCurveDecreasing CostIndustry


Long RunEquilibrium

Long RunEquilibrium






Demand for Wheat

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Perfect Competition Wk-4