Perfect_Competition2003

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Perfect Competition.


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Perfect competition : Perfect competition “Small fish in a BIG pond…”

PERFECT COMPETION : PERFECT COMPETION Characteristics of a Firm in a Perfectly Competitive Market Use our Cost Curves that we have constructed ATC, AVC, MC… Introduce the Horizontal Demand Curve Draw a Firm AND a Market Graph Change the Market Price the Firm receives Normal vs. Economic Profits Long-Run Equilibrium in a Perfectly Competitive Market Shut-Down Rule

PERFECT COMPETION : PERFECT COMPETION There are enough buyers and sellers in the market that no single one can influence the price…FIRMS ARE PRICE TAKERS! The products are largely the SAME…Agricultural Commodities (wheat, corn, beef, pork bellies, etc) FIRMS can enter and exit freely Information about prices and products is freely available to all firms---minimal Asymetrical Information.

PERFECT COMPETION : PERFECT COMPETION To construct of Graph of a FIRM in a Perfectly Competitive Market we MUST understand the concept of a firm as a PRICE TAKER . The KEY is understanding that the PRICE a FIRM gets is EQUAL to MARGINAL REVENUE and AVERAGE REVENUE . All 3 of these are going to come together to form the FIRMS DEMAND CURVE!

PERFECT COMPETION : PERFECT COMPETION IMPORTANT RULE FOR ANY MARKET: FIRMS will produce at the PROFIT MAXIMIZING QUANTITY You will ALWAYS find the PROFIT MAXIZING QUANTITY when: Marginal Revenue=Marginal Cost MR = MC This is the PROFIT MAXIMIZING RULE “Know it, Own it” Locate this point FIRST whenever you draw a graph for a FIRM

PowerPoint Presentation : The Price of a Bushel of Wheat is established in the Commodities Market the Farmer does not have pricing power. He is a PRICE TAKER ! He must take the price he is offered . When he takes his Wheat to Market in this example the Market Price is $5.00 per bushel

PowerPoint Presentation : If the farmer produces 1 bushel of wheat his Total Revenue will be $5.00 (Price X Quantity), his Marginal Revenue will be $5.00 ( Change in Revenue ÷ Change in number of bushels ,0 to 1) and his Average Revenue will be $5.00 ( Total Revenue ($5.00)÷ Total Quantity of Bushels of Wheat (1)).

PowerPoint Presentation : If the farmer produces 10 bushels of wheat his Total Revenue will be $50.00 (Price X Quantity), his Marginal Revenue will be $5.00 ( Change in Revenue ÷ Change in number of bushels, from 9 to 10) and his Average Revenue will be $5.00 ( Total Revenue ($50.00)÷ Total Quantity of Bushels of Wheat (10)).

PowerPoint Presentation : NOTICE : The Price the Farmer gets for a bushel of wheat is EQUAL to Marginal Revenue (MR) AND Average Revenue (AR), REGARDLESS of the number of Bushels he produces.

PowerPoint Presentation : Let’s put this in terms of ELASTICITY of DEMAND for the FIRM…The Formula for Elasticity is Percentage Change in Quantity ÷ Percentage Change in Price. THIS ONE IS EASY!!! Whatever the Percentage Change in Quantity is going to be divided by 0% because the PRICE NEVER CHANGES for the FIRM!! The DEMAND CURVE FOR A FIRM IN A PERFECTLY COMPETITIVE MARKET IS PERFECTLY ELASTIC (Horizontal!!)

PowerPoint Presentation : IMPORTANT: In a Perfectly Competitive Market, because the FIRM is a PRICE TAKER: PRICE = MR =AP = THE FIRM DEMAND CURVE Or simply P=MR=AR=D This is how we will label from now on PRICE axis on the graph for the FIRM

Perfect Competition : Perfect Competition We will now put our two main concepts of the Firm together---the Cost Curves AND the Price=MR=AP=D curve. This will allow us to analyze this market and how changes in this market affect FIRM behavior. View the rest of this presentation slowly

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm is a “Price-Taker”. They have no pricing power—must accept the prevailing Market Price FIRM Market

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The PROFIT MAXIMIZING QUANTITY will be Qf FIRM Market MR=MC

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC FIRM Market MR=MC IMPORTANT NOTE : It is not a coincidence that I put the Price where It will intersect MC at the LOWEST POINT of the ATC Curve . This is going to be The “LONG RUN” condition in a Perfectly Competitive Market. At this intersection The firm will be achieving PRODUCTIVE EFFICIENCY AND ALLOCATIVE EFFICIENCY We will look at this more closely later in this lesson…Just keep it in mind.

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC In the LONG-RUN a Firm in a Perfectly Competitive Market will earn “NORMAL PROFITS” FIRM Market

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC NORMAL PROFITS are a Firms EXPLICIT COSTS + IMPLICIT COSTS FIRM Market

NORMAL PROFITS : NORMAL PROFITS Two components to Normal Profits Explicit Costs- --Tangible costs like rent, wages, utilities, insurance, freight… These are also known as Accounting Costs Implicit Costs- --These are somewhat intangibles costs---They are the entrepreneurs OPPORTUNITY COSTS How much could the entrepreneur earn doing something else AND how much could he “rent out” his capital for if he was not using it.

NORMAL PROFITS : NORMAL PROFITS Accountants care about EXPLICIT COSTS. Economists care out EPLICIT AND IMPLICIT COSTS because it shows if society is properly allocating its resources. If the entrepreneur is more efficient at doing something else then he/she should engage in the activity that they have the “Comparative Advantage” in.

NORMAL PROFITS : NORMAL PROFITS So…If in our example the entrepreneur is earning NORMAL PROFITS in the business he/she is in NOW , then their Opportunity Costs are being met (making the same income they could be making doing something else). If they can RENT out their CAPITAL for the SAME amount they are earning now then they meeting their OPPORTUNITY COSTS. In other words they are doing the best they can with their resources.

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC In the LONG-RUN because of EASY ENTRY AND EXIT firms in a Perfectly Competitive Markets can expect to earn NORMAL PROFITS FIRM Market MR=MC

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC NORMAL PROFITS are the status quo in Perfect Competition. This is the LONG-RUN expectation because of competition and the FIRM is a small player In this market. FIRM Market

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC In the LONG-RUN Price = MR=MC at the LOWEST point of the ATC curve. In other words, the FIRM is BREAKING EVEN. FIRM Market

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm Assume Market conditions change and the DEMAND for the GOOD INCREASES D1 P1 Q1 P1=MR=AR=D

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm The Market price INCREASED. The firm now receives P1 as a price. D1 P1 Q1 P1=MR=AR= D

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm The Profit Maximizing Rule still holds. The firm will produce where MR=MC. D1 P1 Q1 P1=MR=AR=D Qf1 MR=MC

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm The firm will now supply Qf1. At Qf1 the ATC of producing Qf1 in now LESS than The price the firm RECEIVES for Qf1. D1 P1 Q1 P1=MR=AR=D Qf1

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm At Qf1 ATC is LESS THAN the point where MR=MC. If we connect this point to the Price axis we get an ATC of ATC 1 D1 P1 Q1 P1=MR=AR=D Qf1 ATC1

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm The difference between P1 and ATC1 (on the Firm graph) is ECONOMIC PROFITS!! (P1 – ATC1 then multiplied by Qf1 is the dollar amount of ECONOMIC PROFITS) D1 P1 Q1 P1=MR=AR=D Qf1 ATC 1

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm ECONOMIC PROFITS are indicated by the shaded area… D1 P1 Q1 P1=MR=AR=D Qf1 ATC1 1 Area of Economic Profits

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm Because of EASY ENTRY AND EXIT this will not be a long-run situation. In the Long-run ECONOMIC PROFITS send a signal to entrepreneurs to enter this market. D1 P1 Q1 P1=MR=AR=D Qf1 ATC 1 1 Area of Economic Profits

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm Eventually the SUPPLY of this good will INCREASE returning the market to the original Market price. D1 P1 Q1 P1=MR=AR=D Qf1 ATC1 1 Area of Economic Profits Q2 S1 New Equilibrium Price

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ Market for ____ Firm The ECONOMIC PROFITS disappear and we return to the Long-Run state of “Normal Profits” D1 P1 Q1 P1=MR=AR=D Qf1 ATC 1 Area of Economic Profits Q2 S1 New Equilibrium Price

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC Assume Market conditions deteriorate…The demand for this good DECREASES FIRM Market P1 P1=MR=AR=D1 Q 1

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The Market Price is now P1. The price the FIRM receives is BELOW the ATC of producing quantity at Qf . MR < MC!! Remember the FIRM ALWAYS produces where MR = MC. FIRM Market P1 P1=MR=AR=D1 D1 Q1

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The Firm now produces a quantity at Qf1, less than the profit maximizing quantity Qf . FIRM Market P1 P1=MR=AR=D1 D1 Q1 Q f1

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The FIRM now is experiencing ECONOMIC LOSSES . The price in now BELOW the ATC of producing Q F1 . MR now = MC at this point, but ATC of producing QF1 is at this point. FIRM Market P1 P1=MR=AR=D1 D1 Q1 Q f1

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The blue shaded area represents the Area of Economic Loss. The firm is not operating in the area between the ATC and the AVC cost curve…It is NOW not BREAKING EVEN and it is only covering its Variable Cost and SOME of its Fixed Costs. FIRM Market P1 P1=MR=AR=D1 D1 Q1 Q f1 Area of Economic LOSS

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC If MARKET conditions continue to deteriorate, at what point should this FIRM give up and EXIT the Industry? FIRM Market P1 P1=MR=AR=D1 D1 Q1 Q f1 Area of Economic LOSS

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC Because the FIRM is making its AVC and SOME of its AFC, it SHOULD stay in business and hope that the market conditions improve and the price increases back to the LONG-RUN equilibrium. Depending on individual firms cost structures, some firms may exit thereby decreasing the Market SUPPLY and increasing the PRICE… FIRM Market P1 P1=MR=AR=D1 D1 Q1 Q f1 Area of Economic LOSS

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The point of EXIT will be when the PRICE (MR) gets BELOW the LOWEST POINT of the AVC curve!! FIRM Market P1 P1=MR=AR=D1 D1 Q1 Q f1 Area of Economic LOSS Q2 P2 P2=MR=AR=D2

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The point of EXIT will be when the PRICE (MR) gets BELOW the LOWEST POINT of the AVC curve!! This means the FIRM is NOT MAKING AFC NOR AVC …The firm should exit the industry at this time!!! FIRM Market P1 P1=MR=AR=D1 D1 Q1 Q f1 Ecconomic of Economic LOSS Q2 P2 P2=MR=AR=D2 Q3 P3=MR=AR=D3 Area of Economic Loss Shut-Down Now Price BELOW AVC SHUTDOWN

PowerPoint Presentation : PC firms adjust their output in response to changes in price. A PC firm will shut down when MR falls below AVC. Wh en MR is above AVC, the firm will increase its output as price increases according to its upward sloping MC curve. Th e MC curve above AVC shows a direct relationship between Price (AR) and quantity supplied. Th e MC curve above AVC IS THE INDIVIDUAL FIRM'S SUPPLY CURVE! P Q PC Firm MR 1 MR 2 MR 3 MR 4 P 1 P 4 P 3 P 2 MC AVC Firm's Supply curve Perfect Competition M arginal Cost as the firm's Supply Curve

PowerPoint Presentation : The MC increases as ouput increases because of diminishing marginal returns Si nce the MC increases at higher level of ouput, firms require a higher prices in order for them to increase output, so they can maintain the MR=MC level and maximize profits. In other words, the MC curve represents the relationship between price and quantity supplied. This is a direct relationship (demonstrating the law of supply!) C hanges in the prices of variable inputs: For example, a higher minimum wage will shift the cost curve of a firm employing minimum wage workers UP. This corresponds to a leftward shift of the firm's supply curve. Im provements in technology will shift MC down: since better technology makes all workers more productive (shift the MP and AP curves up, thus the MC and AVC curves down). This corresponds with an outward shift of the firm's supply curve P Q PC Firm MC AVC Firm's Supply curve Perfect Competition M arginal Cost as the firm's Supply Curve Points to understand about the MC curve as the firm's short-run supply curve What would cause the firm's supply (MC) curve to shift?

PowerPoint Presentation : In long-run equilibrium, purely competitive firms will produce at the level of output where the price equals firms' marginal cost and its minimum average total cost. This represents Perfect Competition A llocative and Productive Efficiency Allocative Efficiency: P = MC I nterpretation: The right amount of output is being produced. There is neither under nor over-allocation of resources towards a good in a purely competitive industry. If the price were higher than the marginal cost, this is a signal that more output is desired , if price were lower than marginal cost, the signal from buyers to sellers is that less output is desired. Only when P = MC is the right amount of output being produced. Productive Efficiency: P= minimum ATC I nterpretation: The firms are using resources to their maximum efficiency by producing their output at the lowest possible average total cost. Competition forces firms to use resources as efficiently as possible.

Perfect Competition Productive and Allocative Efficiency : Perfect Competition Productive and Allocative Efficiency Productive Efficiency- -Producing at the LOWEST COST, in terms of employing resources A point where Price = the lowest point on the ATC curve

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The FIRM achieves PRODUCTIVE EFFICIENCY when P= LOWEST point on the ATC Curve FIRM Market P=Lowest Point on ATC

Perfect Competition Productive and Allocative Efficiency : Perfect Competition Productive and Allocative Efficiency Allocative Efficiency – Producing at a point that is MOST valued by society. Where society is willing to pay the cost to produce the last unit of good Price = Marginal Cost (MC)

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The FIRM achieves ALLOCATIVE EFFICIENCY when P= Marginal Cost FIRM Market P= Marginal Cost

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC What do you notice about PRODUCTIVE EFFICIENCY AND ALLOCATIVE EFFCIENCY in PREFECT COMPETITION???? FIRM Market P= Marginal Cost P=ATC (lowest point) They are the SAME POINT…The firm is achieving PRODUCTIVE AND ALLOCATIVE EFFICIENCY

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC The FIRM is producing at the lowest possible cost, thereby utilizing societal resources as efficiently as possible, AND they are producing at a cost (price) people are willing to pay…Society benefits the most when firms are in PERFECT COMPETITON!!! FIRM Market P= Marginal Cost P=ATC (lowest point) They are the SAME POINT…The firm is achieving PRODUCTIVE AND ALLOCATIVE EFFICIENCY

PowerPoint Presentation : Price Of ___ P=MR=AR=D MC ATC AVC S* D* P* Q* Quantity of _______ Qf Quantity of ________ In Perfect Competition the Firm will MAXIMIZE its PROFITS where MR = MC FIRM Market

PowerPoint Presentation : Perfect Competition P ractice Free Response Question Luigi's, a typical profit-maximizing pizzeria, is operating in a perfectly competitive industry that is in long-run equilibrium. (a) Draw correctly labeled side-by-side graphs for the pizza market and for Luigi's and show each of the following. (i) Price and output for the market (ii) Price and output for Luigi's (b) Assume that pizza is a normal good and that consumer income falls. Assume that Luigi's continues to produce. On your graphs in part (a), show the effect of the derease in income on each of the following in the short run. (i) Price and output for the industry (ii) Price and output for Luigi's (iii) Area of loss or profit for Luigi's (c) Following the decrease in consumer income, what must be true for Luigi's to continue to produce in the short run? (d) Assume that the market adjusts to a new long-run equilibrium. Compare the following between the initial and the new long-run equilibrium. (i) Price in the industry (ii) Output of a typical firm (iii) The number of firms in the dairy industry

PowerPoint Presentation : Describe the situation in the market below and firm below. ·Show the firm's i) MR , ii) Output , iii) Economic profit or loss · Assuming this is a PC market, describe and illustrate the long run adjustments that will restore this market to Equilibrium. Show on the graphs, for both the industry and the firm, the price and output after long-run adjustments P Q S industry D industry Industry P Q Firm MC ATC AVC MR=D=AR=P 1 P e Perfect Competition P ractice problems

PowerPoint Presentation : Describe the situation in the market below and firm below. ·Show the firm's i) MR , ii) Output , iii) Economic profit or loss · Assuming this is a PC market, describe and illustrate the long run adjustments that will restore this market to Equilibrium. Show on the graphs, for both the industry and the firm, the price and output after long-run adjustments P Q S industry D industry Industry P Q Firm MC ATC AVC MR=D=AR=P 1 P e Perfect Competition P ractice problems

PowerPoint Presentation : Describe the situation in the market below and firm below. ·Show the firm's i) MR , ii) Output , iii) Economic profit or loss · Assuming this is a PC market, describe and illustrate the long run adjustments that will restore this market to Equilibrium. Show on the graphs, for both the industry and the firm, the price and output after long-run adjustments P Q S industry D industry Industry P Q Firm MC ATC AVC MR=D=AR=P 1 P e Perfect Competition P ractice problems

PowerPoint Presentation : Describe the situation in the market below and firm below. Assume price of a close substitute drops. Illustrate the changes that will occur in this market: · Show the new industry price and output ·Show the new firm price and output P Q S industry D industry Industry P Q Firm MC ATC AVC MR=D=AR=P 1 P e Perfect Competition P ractice problems

PowerPoint Presentation : Describe the situation in the market and firm below. Assume this product is featured in a new movie and consumers' tastes shift towards it overnight. Illustrate the changes that will occur in this market: · Show the new industry price and output ·Show the new firm price and output Q Q P S industry D industry Industry P Firm MC ATC AVC MR=D=AR=P 1 P e Perfect Competition P ractice problems

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