perfect competition: short run and long run
TRANSCRIPT
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Prepared by: Jamal Husein
C H A P T E R
5
2005 Prentice Hall Business Publishing Survey of Economics, 2/e OSullivan & Sheffrin
Perfect Competition:Short Run and
Long Run
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2 2005 Prentice Hall Business Publishing Survey of Economics, 2/e OSullivan & Sheffrin
Perfectly Competitive Market
1. There are many firms.
2. The product is standardized, orhomogeneous.
3. Firms can freely enter or leave themarket in the long run.
4. Each firm takes the market price asgiven.
A perfectly Competitive market ischaracterized by:
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3 2005 Prentice Hall Business Publishing Survey of Economics, 2/e OSullivan & Sheffrin
The Short-run Output Decision
The firms objective is to produce thelevel of output that will maximize
profit.
Economic profit= total revenue (TR)
minus total economic cost (TC).
Total revenue = price quantity sold.
The cost structure of the business firm
is the same as the one we studied
earlier.
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The Firms TC Structure (Revisited)
The shape of the total cost curve
comes from diminishing returns
in the short run.
STC TFC STVC Short-run
Total Cost=
Total Fixed
Cost+
Short-run
Total Variable
Cost
Total Cos
Short-run
Cost
Variable
Total
Cost
Fixed
Minute
Rakes per
Output:
STCTVCFCQ
360360448361
4812362
5115363
5620364
6327365
7236366
8448367
10165368
12690369
1661303610
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The Revenue Structure of the
Competitive Business Firm
The perfectly competitive firm isa pr ice-taking firm. This meansthat the firm takes the pricefrom the market.
As long as the market remains
in equilibrium, the firm facesonly one pricethe equi l ibr iummarket pr ice.
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Computing the Total Revenue of a
Price-taker
Since the perfectly competitive firmfaces a constant price, the shape of its
total revenue is an upward-sloping
line. Total revenue changes only with
changes in the quantity sold.
($)
Revenue
Total
Price ($)Minute
Rakes per
Output:
TRPQ
0.00250
25.00251
50.00252
75.00253
100.00254
125.00255
150.00256
175.00257
200.00258
225.00259
250.002510
0
50
100
150
200
250
Co
s
t
in
$
0 1 2 3 4 5 6 7 8 9 10
Output: Rakes per minute
Total Revenue
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The Totals Approach to Profit Maximization
To maximize profit, aproducer finds thelargest gap between totalrevenue and total cost. ProfitTotal Cost
Short-run
($)
Revenue
Total
Minute
Rakes per
Output:
STCTRQ
-36360.000
-194425.001
24850.002
245175.003
4456100.004
6263125.0057872150.006
9184175.007
99101200.008
99126225.009
84166250.0010
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The Marginal Approach
The other way to decide how much
output to produce involves the
marginal principle.
Marginal PRINCIPLEIncrease the level of an activity if its marginal
benefit exceeds its marginal cost, but reduce the
level if the marginal cost exceeds the marginal
benefit. If possible, pick the level at which the
marginal benefit equals the marginal cost.
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Marginal Revenue
The benefit of producing and
selling rakes is the revenue the
firm collects. If the firm sellsone more rake, total revenue
increases by $25.
Marginal benefit = marginal
revenue = market price
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A firm maximizes
profit in accordance
with the marginal
principleby
setting marginal
revenue (or marketprice) equal to
marginalcost.
ProfitCost
Marginal
Short-run
Price ($)
Revenue =
Marginal
Minute
Rakes per
Output:
SMCPQ-36-250
-198251
24252
243253
445254
627255
789256
9112257
9917258
9925259
84402510
The Marginal Rule for Profit Maximization
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Profit Maximization Using the
Marginal Approach
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Economic Profit
Profit per unitequals revenue perunit (or price)minus cost per unit
(or average totalcost).
($25 - $14) = 11
Total economic profit equals:
(priceaverage cost) quantity produced
($25 - $14) x 9 = $99
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Shut-down Decision
The firm should continue to operate ifthe benefit of operating (total revenue)
exceeds the cost of operating, or total
variable cost.TR = (P Q) must be greater than STVC
= SAVC Q, therefore,I f P > SAVC, the f irm should
continue to operate
I f P < SAVC, the f irm should
shut down
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The Shut-down Decision
When price drops to$9, the firm adjusts
output down to 6
rakes per minute to
maintain P=SMC.
The firm suffers a loss, but since priceis
greater than AVC, the firm continues to
operate.
The average
variable cost of
producing 6 rakes
per minute is $6.
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The Shut-down Decision
The firms shut-down priceis theprice at which thefirm is indifferent
between operatingand shutting down.
At $5, P = SAVC. Above this price, the firm is
better off continuing to produce at a loss. Belowthis price, the firm is better off shutting down
because it could not recover its operating cost.
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Short-run Supply Curve
The firms short-run supplycurveshows the relationship
between the market price andthe quantity supplied by the
firm over a period of time
during which one inputtheproduction facilitycannot
be changed.
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The Firms SR Supply Curve
For any price abovethe shut-down price,the firm adjustsoutput along itsmarginal cost curve
as the price levelchanges.
The short-run supply curve is thefirms SMC
curve r ising above the minimum point on the
SAVC curve.
Below the shut-down
price, quantity
supplied equals zero.
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The Market Supply Curve
The short-run market supply curveshows therelationship between the market price and thequantity supplied by all firms in the short run.
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A Market in Long-run Equilibrium
1. The quantity of the product supplied equals
the quantity demanded
2. Each firm in the market maximizes its profit,
given the market price
3. Each firm in the market earns zero economicprofit, so there is no incentive for other firms
to enter the market
A market reaches a long-run equilibrium whenthree conditions hold:
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A Market in Long-run Equilibrium
In short-run equilibrium, quantitysupplied equals quantity demandedand each firm in the market
maximizes profit. In addition to the conditions above,
in long-run equilibrium the typical
firm earns zero economic profitsothere is no further incentive forfirms to enter the market.
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A Market in Long-run Equilibrium
In long-run equilibrium, price = marginal cost (theprofit-maximizing rule), and price = short-run
average total cost (zero economic profit).
Th LR S l C f
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The LR Supply Curve for an
Increasing-cost Industry
An increasing-cost industryis anindustry in which the average costof production increases as the totaloutput of the industry increases.
The average cost increases as theindustry grows for two reasons:
Increasing input prices
Less productive inputs
I d O d A
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Industry Output and Average
Production Cost
Number of
Firms
Industry
Output
Rakes per
Firm
Typical
Cost for
Typical
Firm
Average
Cost per
Rake
50 350 7 $70 $10
100 700 7 84 12
150 1,050 7 96 14
The rake industry is an increasing-cost industry
because the average cost of production increases
as the total output of the industry increases.
D i th L M k t S l
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Drawing the Long-run Market Supply
Curve
Each point on thelong-run supply curve
shows the quantity of
rakes supplied at a
particular price (i.e.,
at a price of $12, 100
firms produce 700
rakes).
The long-run
industry supply curve
is positively-sloped
for an increasing cost
industry.
SR I i D d d th
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SR Increase in Demand and the
Incentive to Enter
An increase in market demand puts upwardpressure on price. As price increases, there is an
opportunity to earn profit in the short run, and the
industry attracts new firms.
Th L Eff t f I i
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The Long-run Effects of an Increase in
Demand
In the short-run,
firms respond to
the increase in
demand byadjusting output in
their existing
production
facilities, and theprice adjusts from
$12 to $17.
Th L Eff t f I i
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The Long-run Effects of an Increase in
Demand
In the long run,
after new firms
enter, equilibrium
settles at $14. The new price is a
higher price thanthe price before the
increase in demand(increasing costindustry).
L S l C f
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Long-run Supply Curve for an
Constant-cost Industry
In a constant-cost industry, firmscontinue to buy inputs at the same
prices.
The long-run supply curve ishorizontalat the constant average costof production.
After the industry expands, the
industry settles at the same long-run
equilibrium price as before.
Long run Supply Curve for the Ice
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Long-run Supply Curve for the Ice
Industry
In the long-run,
the price of ice
returns to its
original level.
An increase in
the demand for
ice increases the
price of ice to $5per bag.