sayre | morris seventh edition perfect competition chapter 8 8-1© 2012 mcgraw-hill ryerson limited

SAYRE | MORRIS Seventh Edition

Perfect Competition

CHAPTER 8

8-1© 2012 McGraw-Hill Ryerson Limited

Learning Objectives:

Perfect Competition

LO1: Distinguish among a firm, an industry, and a market

LO2: Explain what is meant by perfect competition and the market system

LO3: Use two approaches to explain how a firm might maximize its profits

LO4: explain what is meant by break-even price and shutdown price

CHAPTER 8


Learning Objectives:

Perfect Competition

LO5: Explain how a firm’s supply curve is derived

LO6: Explain the effect of a change in market demand or market supply on both the industry and the firm

CHAPTER 8


Industry • a group of producers

Market • the interaction of both producers and consumers

Perfect Competition • a market in which all buyers and sellers are price

takers


LO1


LO1

Self-Test


In what type of market will you find the following types of firms/products?a) Hairdressing salons.

b) Industrial chemicals in Canada.

c) Commercial breweries in Canada.

d) World market for coffee.

e) Rogers Cable in Ontario.

LO1

Self-Test


In what type of market will you find the following types of firms/products?a) Hairdressing salons.

b) Industrial chemicals in Canada.

c) Commercial breweries in Canada.

d) World market for coffee.

e) Rogers Cable in Ontario.

LO1

monopolistic competition

(undifferentiated) oligopoly

(differentiated) oligopoly

perfect competition

monopoly

Conditions for Perfect Competition

1. many small buyers and sellers all of whom are price takers

2. no preferences shown

3. easy entry and exit by both buyers and sellers

4. the same market information available to all


LO2

Conditions for a Market System

1. extensive specialization and trade,

2. perfect competition,

3. private ownership of productive resources, and

4. a legal and social foundation


LO2

Self-Test


In what way(s) is the stock market a good example of perfect competition? In what way(s) is it a bad example?

LO2

Self-Test


In what way(s) is the stock market a good example of perfect competition? In what way(s) is it a bad example?

LO2

The stock market is a good example of perfect competition because there are many (millions) of buyers and sellers, the products sold are homogeneous and there is a great deal of information available about products; on the other hand, some of the buyers and sellers are big enough to affect prices, there is not equal access to information (insider trading), and there is not free entry into the market (you need to hire a broker to buy shares).


LO3

The Competitive Industry and Firm

Total Revenue • total quantity sold (Q) times price (P)

Average Revenue • the amount of revenue received per unit sold

Marginal Revenue • the extra revenue derived from one more unit


LO3

Q PTotal Revenue (TR)Marginal Revenue or P

Output (Q) Q

Q PTotal Revenue (TR)Average Revenue (AR) or P

Output (Q) Q


LO3

Given a perfectly elastic demand curve, Price AR = MR


LO3

Total Profit • the difference between total revenue and total costs:

T TR TC • A firm will maximize profit when

(Total Revenue Total Cost) is greatest.

Break-even Output • the level of output at which the sales revenue of the

firm just covers fixed and variable costs, including normal profit


LO3

Profit and Output


LO3


LO3

Marginal Approach to Profit

If MR > MC → produce more

If MR < MC → produce less

To maximize total profit, the firm should increase production to the point at which:

MR = MC


LO3

Self-Test


Given the data for Marshall’s Meat Ltd., calculate total profits at each output. What are break-even and profit-maximizing outputs?

LO3

Q P TR TC Tп0 50 401 50 1352 50 1803 50 2204 50 2305 50 2506 50 2807 50 3508 50 450

Self-Test


Given the data for Marshall’s Meat Ltd., calculate total profits at each output. What are break-even and profit-maximizing outputs?

LO3

Q P TR TC Tп0 50 0 40 -401 50 50 135 -852 50 100 180 -803 50 150 220 -704 50 200 230 -305 50 250 250 06 50 300 280 207 50 350 350 08 50 400 450 -50

Break-even outputs: 5 and 7; Profit maximizing output: 6

Self-Test


The following data is for Garden Pots Ltd. If the price of a pot is $20, what are the break-even levels of output and what is the profit-maximizing output?

Output (Q) Average Cost (AC) Marginal Cost (MC)0 / /1 $45 $152 25 53 20 10 4 18.75 15 5 19 206 20 257 22 348 25 46

LO3

Self-Test


The following data is for Garden Pots Ltd. If the price of a pot is $20, what are the break-even levels of output and what is the profit-maximizing output?

Output (Q) Average Cost (AC) Marginal Cost (MC)0 / /1 $45 $152 25 53 20 10 4 18.75 15 5 19 206 20 257 22 348 25 46

LO3

Break-even outputs at 3 and 6. (These are the ouputs at which P = AC.)Profit-maximizing output is 5. (This is where P = MC.)

Break-even Price • the price at which the firm makes only normal profits; that

is, makes zero economic profits

• As long as the losses from production are less than total fixed costs, the firm should continue to produce

Shutdown Price • the price that is just sufficient to cover a firm’s variable

costs


LO4

Break-even and Shutdown

Self-Test


The accompanying graph shows the costs for a perfectly competitive firm.a) What is the break-even price?b) What is the shutdown price?

LO4

Self-Test


The accompanying graph shows the costs for a perfectly competitive firm.a) What is the break-even price?b) What is the shutdown price?

LO4

a) Break-even price is $140 (the minimum value of the AC).b) Shutdown price is $100 (the minimum value of the AVC).

• The supply curve for a firm is that portion of its MC curve that lies above its average variable cost curve


LO5

Deriving the Supply Curve

Self-Test


Given the data for a competitive firm, what quantities will the firm produce at prices of $25, $35, $45, $55, $65, and $75?

LO5

Output MC AVC0 — —1 $40 $402 20 303 30 304 40 32.55 50 366 60 407 70 44.38 80 48

Self-Test


Given the data for a competitive firm, what quantities will the firm produce at prices of $25, $35, $45, $55, $65, and $75?

LO5

Output MC AVC0 — —1 $40 $402 20 303 30 304 40 32.55 50 366 60 407 70 44.38 80 48

Price Output (Q)$25 035 345 455 565 675 7

• In the short run the size of both the firm and the industry are fixed; In the long run, both are variable


LO6

Industry Demand and Supply


LO6

Industry Demand and Supply

Increasing Cost Industry • an industry in which the prices of resources and

products both rise as the industry expands

Decreasing Cost Industry • an industry in which the prices of resources and

products both fall as the industry expands

Constant Cost Industry • an industry in which the prices of resources and

products remain unchanged as the industry expands


LO1


LO6

Self-Test


Suppose that demand and supply are as shown below. a)Demand increases by 30 units and new firms enter, causing supply to increase by 30 units. Draw the new curves D2 and S2 and identify equilibrium. What are price and quantity?

LO6

Self-Test


b) As a result of the industry expansion, costs of production increase by $6 per unit. (The supply curve shifts up by $6). Label the new supply curve S3 . What are price and quantity? Identify equilibrium, and draw in the industry’s long-run supply curve.

LO6

Self-Test


a) New equilibrium is at P = $6, Q = 60 b) New equilibrium is at P = $8, Q = 50

LO6

© 2012 McGraw-Hill Ryerson Limited 8-40

• Concepts of firm, industry, and market

• The four types of markets

• The conditions for perfect competition and for a market system

• Why perfectly competitive firms have a horizontal demand curve

• Breakeven and shutdown points

Chapter 8 Summary

© 2012 McGraw-Hill Ryerson Limited 8-41

• Maximizing profit using both marginal and total revenue approach

• Deriving a firm’s supply curve

• Effects on an industry of changes in demand

• The long run supply curve in an increasing-cost, decreasing-cost, and constant-cost industry

Chapter 8 Summary

sayre | morris seventh edition perfect competition chapter 8 8-1© 2012 mcgraw-hill ryerson limited

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