Outline Begin2. Structure3.Profit4.Shut Down5.Supply6.ShiftsEND7 Eff Session 7 Perfect Competition...

Outline

Begin 2. Structure 3.Profit 4.Shut Down 5.Supply 6.Shifts END7 Eff

Session 7 Perfect Competition

Chapter 8 in the text

Right mouse click to advance, or Use the arrow keys to navigate in the presentation : the up or right arrow to advance, the down or left arrow to go back;

This image appears on every slide in the upper left and operates as a hyper link to the slide “Lecture Outline”

Tips for Navigation in the presentation:

Outline

Begin 2. Structure 3.Profit 4.Shut Down 5.Supply 6.Shifts END7 Eff2

Wal-Mart engaging in price competition

CHAPTER 8

Source: WSJ 12/8/03

E-tailing

•PRICING WARS ARE AN EXAMPLE OF COMPETITION AMONG FIRMS

•Wal-Mart Fires the First Shot in Holiday-Toy Pricing War

In late September, a full three months before Christmas, and a month before hot holiday items normally are promoted, Wal-Mart Stores slashed the price on Fisher-Price's newest dancing doll to $19.46 -- a stunning 22% discount to the Toys "R" Us price of $24.99.

•The steep and early price cuts are roiling the industry. Yesterday, Toys "R" Us acknowledged Wal-Mart's moves caught it by surprise and hurt its third-quarter results.

• Source: Ann Zimmerman, Joseph Pereira and Queena Sook Kim. Wall Street Journal (Eastern edition). New York, N.Y.: Nov 19, 2003. p. B.1

Outline


eBay as a source of price informationFor years, eBay Inc. has let its users buy and sell almost anything. Now it wants to become the blue book for just about everything.Earlier this year, the auction Web site quietly began selling to other companies huge volumes of data related to the site's auctions. Among the hottest data for sale: the average selling prices on eBay of all kinds of products, from Sony DVD players to Ford Explorers.EBay is making the push at a time when its site has grown monstrously large, with enough auctions of items across various categories that the company says it can provide representative market prices. eBay is a source of price information for consumers and makes sellers price products competitively. This information contributes to making the demand curves facing the firms be horizontal.Source: WSJ 12/8/03 At eBay Even Sales Prices are for Sale, By Nick Wingfield

Outline

Outline


Session 7 Lecture Outline: Perfect Competition

1.0 First Slide2.0 The Market Structure of Perfect Competition 3.0 Profit Maximization4.0 Break Even and Shut Down Points5.0 Supply Curve6.0 Demand Shifts7.0 EfficiencyLast Slide: Review

Outline


2.0 Market Structure

2.1 Terminology

2.2 Perfect Competition

2.3 Market Structure Matrix

2.4 Summary of Formulas

Outline


2.1 Market Structure Terminology

Key Characteristics Describing Market Structure

Number of suppliers• Many or few

Product’s degree of uniformity• Do firms in the market supply identical products or are

there differences across firms?

The ease of entry into the market• Can new firms enter easily or are they blocked by natural

or artificial barriers?

Control over Price• Do sellers have full control over the selling price?Outline

Outline


2.2 The Perfectly Competitive Market Structure

Perfect CompetitionMany buyers and sellers so many that each buys and sells only a tiny fraction of the total amount exchanged in the market

Firms sell a standardized or homogeneous product

Sellers has no control over price, is a price taker, it is determined by the market.

Firms and resources are freely mobile over time they can easily enter or leave the industry

Outline

Outline

8

2.3 Market Structure Matrix

# of suppliers Product Standardized

Entry/Exit Control over Price

Perfect Competition(Session 7)

Many Yes Very easy None

Monopoly(Session 8)

One Unique, no close substitutes

Blocked Considerable

Monopolistic Competition(Session 9)

Many Not much as much differences as they want you to think

Relatively easy

Some, but within narrow limits

Oligopoly(Session 9)

Few Not much Significant obstacles

Limited by interdependence, but considerable with collusion

Outline


2.4 Summary of Formulas

Profit = TR – TCREVENUE:

Total Revenue: TR = q pAverage Revenue: AR = TR / qMarginal Revenue: MR = TR/ q

COST:Total Cost: TC = FC + VC Average Variable Cost: AVC = VC / qAverage Fixed Cost: AFC = FC / qAverage Total Cost: ATC = TC / q Marginal Cost: MC=TC/ q

Outline

Outline


3.0 Profit Maximization

3.1 Horizontal (price taker)3.2 Revenue Concepts3.3 Profit = TR – TC3.4MR = MC Approach3.5 Graphically3.6 Econ Lab

Outline

Begin 2. Structure 3.Profit 4.Shut Down 5.Supply 6.Shifts END7 Eff 11

3.1 A Graphic Illustrating Market Equilibrium

and the Firm’s Demand Curve in Perfect

Competition

Bushels ofwheat per day

$5

0 1,200,000

S

D

Pri

ce p

er

bu

sh

el

(a) Market Equilibrium

Pri

ce

per

bu

shel

$5

0Bushels of

wheat per day

d

5 10 15

(b) Firm’s Demand

The market price of wheat of $5 per bushel is determined in the left panel by the intersection of the market demand curve and the market supply curve. Once the market price is established, any farmer can sell all he or she wants at that market price.

Outline

Outline


3.2 Revenue Concepts

The Demand Curve represents the Price each output is sold at.Marginal Revenue is the change in total revenue attributable to each additional unit sold. MR = chg TR / chg qBecause the perfectly competitive firm sells each additional unit at the same price, the Marginal Revenue Curve is the Demand Curve.Average Revenue is the ratio of total revenue to total quantity sold. It represents the average price received for each unit. AR = TR / qBecause the perfectly competitive firm sells each additional unit at the same price, the Marginal Revenue Curve is the Average Revenue Curve.Regardless of the rate of output, the following equality holds along the firm’s demand curve

Market price = marginal revenue = average revenue

Outline


3.3a ProfitThe firm maximizes economic profit by finding the rate of output at which total revenue (TR) exceeds total cost (TC) by the greatest amount

Profit = TR - TC

Total revenue is simply output times the price per unitTR = P x q

First will will show from hypothethical data where the profit maximizing output level is, then we will show how this can be determined using the relationship MR = MC

Outline

Outline


(1) (2) (3) = (1) (2) (4) (5) (6) = (4) + (1) (7) = (3) - (4) Bushels of Marginal Wheat Revenue Total Total Marginal Average Economic per day (Price) Revenue Cost Cost Total Cost Profit or (q) (p) (TR = q p) (TC) MC=TC/ Q ATC = TC / q Loss = TR - TC 0 -- $0 $15.00 -- -$15.00 1 $5 5 19.75 $4.75 $19.75 -14.75 2 5 10 23.50 3.75 11.75 -13.50 3 5 15 26.50 3.00 8.83 -11.50 4 5 20 29.00 2.50 7.25 -9.00 5 5 25 31.00 2.00 6.20 -6.00 6 5 30 32.50 1.50 5.42 -2.50 7 5 35 33.75 1.25 4.82 1.25 8 5 40 35.25 1.50 4.41 4.75 9 5 45 37.25 2.00 4.14 7.75 10 5 50 40.00 2.75 4.00 10.00 11 5 55 43.25 3.25 3.93 11.75 12 5 60 48.00 4.75 4.00 12.00

13 5 65 54.50 6.50 4.19 10.50 14 5 70 64.00 9.50 4.57 6.00 15 5 75 77.50 13.50 5.17 -2.50 16 5 80 96.00 18.50 6.00 -16.00

The individual farmer’s output possibilities measured in bushels of wheat per day are shown in column (1)

Column (2) has the market price.

Total revenue is in column (3) = column (1) column (2) P q

Total cost is shown in column (4)

Economic Profit is in column (7) = Total revenue in column (3) minus Total cost in column (4)

3.3b Profit, Hypothethical Firm

Outline

Outline


3.3c: Short-Run Profit Maximization Graph

$60

48

15

0

Total cost Total revenue

( $5 × q )

Maximum economicprofit $12

Bushels of wheat per day 5 7 10 12 15

To

tal

do

lla

rs

(a) Total Revenue Minus Total CostAt output less than 7 bushels and greater than 14 bushels, total cost exceeds total revenue economic loss measured by the vertical distance between the two curves.

Total revenue exceeds total cost between 7 and 14 bushels per day economic profit is maximized at the rate of output of 12 bushels of wheat per day.

Outline


3.4a MC = MR Approach

The profit-maximizing rate of output occurs where marginal revenue equals marginal costMarginal revenue, MR, is the change in total revenue from selling another unit of output

MR = TR/ qSince the firm in perfect competition is a price taker, marginal revenue from selling one more unit is the market price MR = PMarginal cost (MC) is the change in total cost resulting from producing another unit of output

MC=TC/ Q

The next slide provides an example in a Tables we look for where the output level where the difference between MR and MC is smallest, and the slide after that shows the same in a graph

Outline


(1) (2) (3) = (1) (2) (4) (5) (6) = (4) + (1) (7) = (3) - (4)Bushels of Marginal Wheat Revenue Total Total Marginal Average Economic per day (Price) Revenue Cost Cost Total Cost Profit or (q) (p) (TR = q p) (TC) MC=TC/ Q ATC = TC / q Loss = TR - TC 0 -- $0 $15.00 -- -$15.00 1 $5 5 19.75 $4.75 $19.75 -14.75 2 5 10 23.50 3.75 11.75 -13.50 3 5 15 26.50 3.00 8.83 -11.50 4 5 20 29.00 2.50 7.25 -9.00 5 5 25 31.00 2.00 6.20 -6.00 6 5 30 32.50 1.50 5.42 -2.50 7 5 35 33.75 1.25 4.82 1.25 8 5 40 35.25 1.50 4.41 4.75 9 5 45 37.25 2.00 4.14 7.75 10 5 50 40.00 2.75 4.00 10.00 11 5 55 43.25 3.25 3.93 11.75 12 5 60 48.00 4.75 4.00 12.00 13 5 65 54.50 6.50 4.19 10.50 14 5 70 64.00 9.50 4.57 6.00 15 5 75 77.50 13.50 5.17 -2.50 16 5 80 96.00 18.50 6.00 -16.00

Marginal revenue is presented in column (2) while marginal cost is in column (5).

The firm will increase quantity supplied as long as each additional unit adds more to total revenue that to total cost as long as marginal revenue exceeds marginal cost.

Marginal revenue exceeds marginal cost for the first 12 bushels of wheat.The farmer, as a profit-maximizer will limit output to 12 bushels per day.

3.4b Hypothethical Firm

Outline


3.5: Profit Maximization Graphically

$5

4

0 15

Marginal cost

Average total cost

d Marginal revenue

average revenue

e

a

Profit

Bushels of wheat per day 12 10 5

Do

lla

rs p

er

un

it

(b) Marginal Cost Equals Marginal Revenue

The marginal cost curve intersects the marginal revenue curve at point e where output is 12 bushels per day.

At rates of output less than 12 bushels, marginal revenue exceeds marginal cost firm can increase profit by expanding output. At higher rates of output, marginal cost exceeds marginal revenue the firm could increase profit by reducing output.

Profit appears in the blue shaded rectangle. The height of the rectangle, ae, equals the price of $5 minus the average cost of $4 per unit profit of $1 per bushel.

Outline


3.6 Econ Lab

Outline


Click to advance to next slide

20

Outline


4.0 BREAK EVEN , SHUT DOWN POINTS

4.1 Shut Down4.2 Break Even

21

Outline


4.1a Minimizing Short-Run Losses

Sometimes the price that the firm is required to “take” will be so low that no rate of output will yield an economic profit

Faced with losses at all rates of output, the firm has two options

It can continue to produce at a loss, or

Temporarily shut down

It cannot exit (go out of business) in the short run because by definition the short run is a period too short to allow existing firms to leave or new firms to enter

Outline

Outline


4.1b Fixed Cost and Minimizing Losses

The firm has two types of costs in the short run

Fixed costVariable cost

A firm that shuts down in the short run must still pay its fixed costsBut, by producing, a firm’s revenue may more than cover variable cost a firm will produce if the revenue thus generated exceeds the variable cost of production can cover a least a portion of its fixed costOutline

Outline


4.1c Shut Down Decision

q1

0 Quantity per period

d1

Average variable cost

1

Marginal cost

p1

Shutdownpoint

2

q2

p2 d

2

q5Do

llars

per

un

it

At a price as low as p1, the firm will shut down rather than produce at point 1, because the price is below average variable cost at all output rates the loss-minimizing output rate at a price of p1 is zero as shown by q1

At a price of p2, the firm will be indifferent between producing q2 and shutting down because either way the loss will equal fixed cost since the price just equals average variable cost. Point 2 is called the shutdown point.

Outline


4.2 Break-even

q1

0Quantity per period

d1

Average total cost

Average variable cost4

1

Marginal cost

p1

Shutdownpoint

2

q2

p2 d

2

q3

3p

3 d

3

Break-evenpoint

q4

p4 d

4

q5

p5

5d

5D

olla

rs p

er u

nit

If the price is p3, the firm will produce q3 to minimize its loss while at p4, the fiPowerpoint Lecture Notesrm will produce q4 to earn just a normal profit the break-even point.If the price rises to p5, the firm will earn a short-run economic profit by producing q5

In the long run all costs are variable (i.e. there is no AFC cueve, and the AVC is the ATC curve) , hence in the long run the break-even point is the also the shut down point

Outline


5.0 Supply Curve

5.1 Firm’s Short Run Supply5.2 Market Supply

Outline


5.1a Short-Run Firm Supply Curve

As long as the price covers average variable cost, the firm will supply the quantity resulting from the intersection of its upward-sloping marginal cost curve and its marginal revenue, or demand curve

Thus, that portion of the firm’s marginal cost curve that intersects and rises above the lowest point on its average variable cost curve becomes the short-run firm supply curveOutline

Outline


5.1b: Short-Run Supply Curve

q1

0 Quantity per period

d1

Average total cost

Average variable cost

4

1

Marginal cost

p1

2

q2

p2 d

2

q3

3p

3 d

3

q4

p4 d

4

q5

p5

5d

5D

olla

rs p

er u

nit

The quantity supplied when the price is p2 or higher is determined by the intersection of the firm’s marginal cost curve and its demand or marginal revenue curve.

The solid portion of the short-run supply curve indicates the quantity the firm is willing and able to supply in the short run at each alternative price.

The short-run supply curve is the upward-sloping portion of the marginal cost curve,

beginning at point 2.

Outline


5.2a Aggregating Individual Supply to Form

Market Supply P

rice

per

un

it

p'

p

0 10 20

(a) Firm A

SA

Quantity per period

p'

p

0 30 60

(d) Industry, or market, supply

Quantity per period

(b) Firm B (c) Firm C

p'

p

0 10 20

p'

p

0 10 20

SCSB

Quantity per period

Quantity per period

SAS

BS

C S

The short-run industry supply curve is the horizontal sum of all firms’ short-run supply curves horizontal summation of the firm level marginal cost curves

At a price below p, no output is supplied. At a price of p, each of the three firms supplies 10 units, for a market supply of 30 units, and at a price of p', each firm supplies 20 units the market supply is 60 units.

Outline

Outline


5.2b Relationship Between Short-Run Profit Maximization and Market Equilibriuim

Do

lla

r s p

er

un

it

$5 4

0 5 10 12Bushels of wheatper day

Bushels of wheatper day

(a) Firm

d

Pri

ce p

er

un

it

$5

0 1,200,000

(b) Industry, or market

D

ATCAVC

Profit

MC = SMC = s

If we suppose there are 100,000 identical wheat farmers, their individual supply curves are summed horizontally to yield the market supply curve which is shown in the right panel where the market price of $5 is determined. At this price, each farmer produces 12 bushels per day, as shown in the left panel, for a total quantity supplied of 1,200,000 bushels per day each farmer earns an economic profit of

$12 per day as shown by the blue shaded rectangle. Outline

Outline


6.0 Demand Shifts

6.1 Equilibrium6.2 Demand Increase6.3 Demand Decrease6.4 Practice

Outline


6.1 Long Run Equilibrium for the Firm and the

Industry

p

0

d

Quantity per period

MC

ATC

e

LRAC

q

Do

llars

per

un

it

p

0

Q Quantity per period

Pri

ce p

er u

nit

D

(a) Firm (b) Industry, or market

In the long run, market supply adjusts as firms enter or leave, or change their size. This process continues until the market supply intersects the market demand at a price that equals the lowest point on each firm’s long-run average cost curve at point e with each firm producing q units. At point e, marginal cost, short-run average total cost and long-run average cost are all equal.

S

Outline

Outline


6.2a: Long-Run Adjustment to an Increase in Demand

Quantityper period

Quantity per period

0

ATC

MC

LRAC

(a) Firm

0

D

a

Qa

(b) Industry, or Market

p

S

Do

lla

rs p

er

un

it

Pri

ce

pe

r u

nit

p

d

q

d'

D'

Profitp'

q'

p' b

Qb

Suppose the initial point of equilibrium is given as point a in the right hand panel where the market clearing price is p and the market quantity is Qa the individual firm supplies q units and earns a normal profit.Now suppose market demand increases as shown by the shift from D to D' the market price increases in the short run to p'. Each firm responds to the higher price by expanding output along its short-run supply, or marginal cost curve the quantity supplied increases to q' Outline

Return to 6.0 Demand Shifts

Outline


6.2b: Long-Run Adjustment to an Increase in Demand

0

ATC

MC

LRAC

Quantityper period

(a) Firm

0

D

a

Qa Quantity

per period


p

S

S*

Do

lla

rs p

er

un

it

Pri

ce

pe

r u

nit

p

d

q

d'

D'

p'

q'

p' b

Qb

S'

c

QcIn the long run, economic profit attracts new firms additional supply to the market shifting out the market supply curve market price to fall. Firms continue to enter as long as they earn economic profit the market supply eventually shifts out to S', where it intersects D' at point c, returning price to its initial equilibrium level, p the demand curve facing the individual firm shifts back down from d' to d firms again earning a normal profit. Even though industry output increases from Qa to Qb, each firm’s output returns to q new firms provide the additional output

Outline


Outline


6.3a: Long-Run Adjustment to a Decrease in Demand


Do

llars

per

un

it

p

p"

0

d

MC

ATC

e

LRAC

Quantityper period

(a) Firm

0

S

Quantityper period

Qa

D

ap

Qg

q"

d"

Lossp"

D"

f

Qf

Pri

ce p

er u

nit

q

Each firm responds in the short run by cutting its output to q", where marginal cost equals the now-lower marginal revenue. Market output falls to Qf each firm operates at a loss as shown by the red shaded area.

Again, suppose that the initial long-run equilibrium is shown by point a in the market and point e for the firm. Now suppose that market demand for this product declines from D to D" the market price falls to p" the demand curve facing each firm drops to d"


Outline


6.3b: Long-Run Adjustment to a Decrease in Demand


Do

llars

per

un

it

p

p"

0

d

MC

ATC

e

LRAC

Quantityper period

(a) Firm

0

S

Quantityper period

Qa

D

ap

g

S"

Qg

q"

d"

Lossp"

D"

f

Qf

S*

Pri

ce p

er u

nit

q

The short-run loss, if it continues, will in the long run force some firms out of this business market supply will decrease from S to S" price increases back to p and the new market equilibrium is shown by point g. Market output has fallen to Qg and the remaining firms are just earning a normal profit as firm demand shifts back to d.

Outline Return to 6.0 Demand Shifts

Outline


6.4a Draw Demand ShiftsYou can draw and drop the objects to practice demand shifts

37

For example: In the right graph draw the diagram of market price, in the left draw the firm equilibrium, in the right increase demand and in the left show the profit for the firm using the dots CLICK HERE FOR ANSWER

Outline6.4 B ANSWER

For example: In the right graph draw the diagraom of market price, in the left draw the firm equilibrium, in the right increase demand and in the leftshow the profit for the firm using the dots. CLICK HERE TO RETURN TO TOOLBOX slide

38

Outline


7.0 Efficiency

7.1 Productive and Allocative Efficiency7.2 Productive: least cost7.3 Allocative: highest consumer valuation7.4 Graphically

Outline


7.1 Perfect Competition and Efficiency

How does perfect competition stack up as an efficient allocator of resources?

There are two concepts of efficiency used to benchmark market performance

Productive efficiency refers to producing output at the least possible costAllocative efficiency refers to buying the output at the least possible pricePerfect competition guarantees both allocative and productive efficiency in the long runOutline

Outline


7.2 Productive EfficiencyAka Producer SurplusProductive efficiency occurs when the firm produces at the minimum point on its long-run average-cost curve the market price equals the minimum average total cost

The entry and exit of firms ensure that each firm produces at the minimum point on its short-run and long-run average cost curve

Thus, perfect competition produces output at the least possible cost per unit in the long runOutline

Outline


7.3 Allocative EfficiencyAka Consumer Surplus

Allocative efficiency occurs when the marginal benefit that consumers attach to the final unit purchased, just equals the opportunity cost of the resources employed to produce that unit.

The demand curve reflects the marginal benefit that consumers attach to each unit

In perfect competition, at the equilibrium price consumers marginal benefit equals the marginal cost of supplying the last unit soldOutline

Outline


7.4 Graphically

In the short run, producer surplus is the total revenue producers are paid minus their variable cost of production

In our example, the market-clearing price is $10 per unit, and producer surplus is the red shaded area under the price but just above the supply curve.

The combination of consumer surplus and producer surplus shows the gains from voluntary exchange. Productive and allocative efficiency in the short run occurs at point e, which also is the combination of price and quantity that maximizes the sum of consumer and producer surplus.

5

Producer surplus

Consumer surplus

D

S

m

e

Quantity per period

Dollars per unit

0 100,000 120,000 200,000

6

10

Outline


END OF PRESENTATION

Pics linked to topics in lecture

Outline



Outline Begin2. Structure3.Profit4.Shut Down5.Supply6.ShiftsEND7 Eff Session 7 Perfect Competition...

Documents

Transcript of Outline Begin2. Structure3.Profit4.Shut Down5.Supply6.ShiftsEND7 Eff Session 7 Perfect Competition...