chapter 9 supply under perfect competition introduction to economics (combined version) 5th edition
TRANSCRIPT
Chapter 9Supply Under
Perfect Competition
Introduction to Economics (Combined Version) 5th Edition
Market Structure Market structure is the characteristics of the market
environment; such as the nature of the product, number and size of competitors, and conditions of entry and exit, that shape the ways in which a firm interacts with its customers and competitors.
Market structure matters because it helps determine the constraints a firm faces in making decisions related to pricing and profit maximization.
Introduction to Economics (Combined Version) 5th Edition
Perfect Competition
Many small firms Each has small market share Product is homogeneous Entry is unrestricted Equal access to information Example: Some kinds of
farming
Introduction to Economics (Combined Version) 5th Edition
Monopoly One firm 100% market share Unique product Restricted entry Possible restrictions on
information Example: Post office
monopoly on first-class mail
Introduction to Economics (Combined Version) 5th Edition
ww.pdclipart.org
Oligopoly
A few firms At least some have large
market shares Homogeneous or
differentiated products Entry may be restricted Possible restrictions on
information Example: Airlines
Introduction to Economics (Combined Version) 5th Edition
Monopolistic Competition Many firms Each has small market
share Product differentiated by
quality, location, style, etc.
Unrestricted entry Possible restrictions on
information Example: Hotels in a
resort community
Introduction to Economics (Combined Version) 5th Edition
Demand for a Perfect Competitor The perfectly competitive firm is a price taker It is so small relative to the market as a whole that its decisions
do not significantly affect the market price, so the demand curve it faces is perfectly elastic.
Introduction to Economics (Combined Version) 5th Edition
Profit Maximization for Perfect Competitor Assume a perfectly competitive
firm and a market price P=50 The maximum profit will be
earned at a quantity Q* where P = MC and MC is increasingAt a lower Q, P>MC so
revenue from one more unit will exceed the cost of that unit
At a higher Q, P<MC so revenue from one more unit will be less than the cost of that unit
Introduction to Economics (Combined Version) 5th Edition
Profit Maximization vs. Loss Minimization
If P>ATC where P=MC, then the firm will earn a positive profit at that point (point a)
If ATC>P>AVC where P=MC, then “profit maximization” will really mean loss minimization, for example, point b
Introduction to Economics (Combined Version) 5th Edition
Profit Maximization vs. Loss Minimization At point b, price is enough to
pay variable costs in full. After variable costs are paid,
there is enough revenue left to pay part, but not all of fixed costs.
If market conditions are expected to return to profitability in the future, short-run losses are minimized by operating at point b
Introduction to Economics (Combined Version) 5th Edition
Example: Housing Construction During a downturn in the
housing market, a building contractor may continue to operate even though prices for contractor services are low.
Revenue is enough to cover variable costs (workers’ wages) with enough left over to pay part, but not all, of fixed costs (tools and heavy equipment).
When the housing market recovers, prices will rise and profits will return.
Introduction to Economics (Combined Version) 5th Edition
Short-Run Shutdown Suppose that the firm is
expected to be profitable in the long run but, in the short run, P<AVC
The firm should consider shutting down in the short-run to minimize operating losses
Possible exceptions: Continue operating to avoid losing
your regular customers Continue operating to retain
loyalty of key employees
Introduction to Economics (Combined Version) 5th Edition
Example: Seasonal Resorts Some ski resorts do not have
enough demand to even cover their variable costs of operation in the summer.
They shut down in the summer to minimize losses.
Other mountain resorts have enough demand from hikers and sightseers to remain open all year.
Exercise: Draw diagrams to illustrate each possibility.
Introduction to Economics (Combined Version) 5th Edition
MC Curve and the Supply Curve As the price increases, the
profit-maximizing quantity will increase
The positively-sloped segment of the marginal cost curve above minimum average variable cost can be considered the firm’s supply curve
Points where price intersects the negatively-sloped segment of the MC curve are not part of the supply curve
Introduction to Economics (Combined Version) 5th Edition
Industry Supply Curve A short-run industry supply curve can be obtained by summing
the supply curves of individual firms. Here this method is shown for the first three firms in an industry. The supply curves of additional firms would be added in the same way.
Introduction to Economics (Combined Version) 5th Edition
Long-Run EquilibriumLong-run equilibrium in a
perfectly competitive industry requires that the firm
1. have no short-run incentive to change the level of its output
2. have no long-run incentive to change the size of the plant used to produce its output
3. have no long-run incentive to enter or leave the industry
This requires that price, short-run marginal cost, short-run average total cost, and long-run average cost all have the same value in equilibrium
Introduction to Economics (Combined Version) 5th Edition
Entry in Perfect Competition An increase in demand temporarily increases price. With positive
economic profit, new firms will enter. Supply shifts to right and price returns to AVC.
Introduction to Economics (Combined Version) 5th Edition
Exit from Perfect Competition A decrease in demand temporarily lowers price. With negative
economic profit (assuming no sunk costs), some firms leave the market. As they do, supply shifts to left and price returns to AVC
Introduction to Economics (Combined Version) 5th Edition
Industry Supply with Rising Input Prices This pair of diagrams show what happens if industry expansion causes input
prices to rise. As output expands, rising input prices push up the firm’s marginal cost curve from MC1 to MC2, and its average total cost from ATC1 to ATC2. The result is a new long-run equilibrium price that is higher than the initial price. The long-run industry supply curve thus has a positive slope.
Introduction to Economics (Combined Version) 5th Edition