PERFECT COMPETITION: is an industry in which

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ECON 101 CHAPTER 12
PERFECT COMPETITION

• PERFECT COMPETITION is an industry in which
• Many firms sell identical products to many buyers
• There are no restrictions on entry into the
  industry
• Established firms have no advantage over new ones
• Sellers and buyers are well informed about prices
• Example Farming, the manufacture of plastic
  shopping bags, plates and cups, dry cleaning,
  photo finishing, etc.

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• Perfect competition arises if the minimum
  efficient scale of a single producer is small
  relative to the demand for the good or service .
• Each firm is perceived to produce a good or
  service that has no unique characteristics so the
  consumers dont care which firm they buy from.

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• Minimum Efficient Scale A firms minimum
  efficient scale is the smallest quantity of
  output at which long run average cost reaches its
  lowest level.
• Price Taker Firms in perfect competition are
  said to be price takers. A price taker is a firm
  that cannot influence the price of a good or
  service.

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• Economic Profit and Revenue
• A firms goal is to maximize economic profit.
• Economic profit total revenue total cost
• Total revenue price x quantity
• Total cost opportunity cost of production
•  
• Opportunity cost of production includes the
  normal profit, the return that the firms
  entrepreneur can obtain in the best alternative
  business.

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• Marginal Revenue is the change in total revenue
  that results from a oneunit increase in the
  quantity sold.
•  
• Change in total revenue
• Marginal Revenue ----------------------------
  ----
• Change in quantity sold

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Figure 12.1 Demand, Price, and Revenue in
Perfect Competition
50
50
Sidney's demand curve
TR
S
Market demand curve
Total revenue (dollars per day)
Price (dollars per sweaters)
Price (dollars per sweaters)


a
MR
25
25
225
D
0
9
20
0
10
20
0
9
20
Quantity (thousands of sweaters per day)
Quantity (sweaters per day)
Quantity (sweaters per day)
In perfect competition, marginal revenue price.
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• THE FIRMS DECISIONS IN PERFECT COMPETITION
• The task of the competitive firm is to make the
  maximum economic profit possible, given the
  constraints it faces. To achieve this objective,
  a firm must make four key decisions
• Two in the short run
• 1.   whether to produce or not
• 2.   what quantity to produce
•  Two in the long run
• 1. Whether to increase or decrease its plant
  size
• 2.  Whether to stay in the industry or leave it

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• Profit Maximizing Output
• A perfectly competitive firm maximizes economic
  profit by choosing its output level.
• Total Revenue, Total Cost and Economic Profit
• One way of finding the profit maximizing output
  is to study a firms total revenue and total cost
  to find the output level at which total revenue
  exceeds total cost by the largest amount. 
• BreakEven point An output at which total cost
  equals total revenue is called a break- even
  point.

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• Marginal Analysis 
• Another way of finding the profit-maximizing
  output is to determine the output at which MR
  equals MC.
• If MR lt MC an increase in output decrease
  economic profit
• If MR gt MC an increase in output increase
  economic profit
• If MR MC economic profit is maximized

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Figure 12.3 Profit-Maximizing Output
Profit maximization point
Lost from 10th sweater
30

MR
25
Profit from 9th sweater
20
Marginal revenue and marginal cost (dollars per
sweater)
10
0
8
9
10
Quantity (sweaters per day)
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Figure 12.4 A Firm's Supply Curve
MC
S


31
31
MR2


25
25
MR1
Shutdown point
Price and Cost (dollars per sweater)
Price (dollars per sweater)
AVC
s
s


17
17
MR0
0
7
9
10
0
7
9
10
Quantity (sweaters per day)
Quantity (sweaters per day)
(a) Marginal cost and average variable cost
(b) Sidney's supply curve
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• A perfectly competitive firms short-run supply
  curve shows how the firms profit-maximizing
  output varies as the market price varies, other
  things remaining the same.
• The shutdown point is the output and price at
  which the firm just covers its total variable
  cost.

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• If the price is above minimum average variable
  cost, Sidney maximizes profit by producing the
  output at which marginal cost equals price.
• Above the shutdown point (where AVCMC) the
  Supply curve is the same with the MC curve.
• At prices below minimum average variable cost,
  Sidney shuts down and produces nothing.

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Figure 12.5 Industry Supply Curve
The industry supply schedule is the sum of the
supply schedules of all individual firms
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OUTPUT, PRICE AND PROFIT COMPETITION

• Short-Run Equilibrium Industry demand and
  industry supply determine the market price and
  industry output. (See Figure 12.6)
• A Change in Demand Changes in demand bring
  changes to short-run industry equilibrium.
• If demand increase, the demand curve shifts to
  rightward and price increases. If demand
  decreases the demand curve shifts leftward and
  price decreases.

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• Figure 12.6 Short-Run Equilibrium

(a) Equilibrium
(b) Change in equilibrium
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• Profits and Losses in the Short-Run
• In the short-run, the firm may have loss or
  profit or may just break even. To find which of
  these outcomes occurs , we compare the firms TR
  and TC, or we compare the price and average total
  cost.
• If price gt ATC, firm makes economic profit
• If price lt ATC , firm makes economic loss

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Figure 12.7 Three Possible Profit Outcomes in
the Short Run
MC
MC
MC
30
30
30
ATC
ATC
ATC
Breakeven point

25
25
25
Economic profit
ARMR
Price and cost (dollars per sweater)



20.33
20.14
20
Economic loss
ARMR
15
17.00
15
ARMR
0
9
10
0
7
10
0
8
10
Quantity (sweaters per day)
Quantity (sweaters per day)
(c) Economic loss
(a) Normal profit
(b) Economic profit
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• Long Run Adjustments
• In the long run, an industry adjusts in two ways
  (Figure 12.8)
• 1. Entry and Exit
• 2. Changes in plant size
• The Effects of Entry
• As new firms enter an industry, the price falls
  and the economic profit of each existing firm
  decreases.
•  The Effects of Exit
• As firms leave an industry, the price rises and
  the economic loss of each remaining firm
  decreases.

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• Figure 12.8 Entry and Exit

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• Long Run Equilibrium
• Long-run equilibrium occurs in a competitive
  industry when economic profit is zero (when firms
  earn normal profit). There is no entry, exit or
  change in plant size.