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Firms in Perfectly Competitive Markets

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Firms in Perfectly Competitive Markets

MARKET STRUCTURE
PERFECT MONOPOLISTI CHARACTERISTI COMPETITIO C OLIGOPOLY C N COMPETITION MONOPOLY

Number of firms Type of product Ease of entry Examples of industries

Many Identical High Wheat Apples

Many Differentiated High

Few Identical or differentiated Low

One Unique Entry blocked First-class mail delivery Tap water

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Selling DVDs Manufacturing Restaurants computers Manufacturing automobiles

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The Competitive Market for Microsoft Stock The software market has long been dominated by the Microsoft Corporation. Chairman Bill Gates is one of the few corporate executives who is well-known on Main Street as well as Wall Street. But unlike its software, shares of Microsofts common stock are sold in a competitive market. Over 60 million shares of Microsoft stock, out of over 10 billion shares outstanding, were sold every business day in 2005. Since each share is exactly the same as any other, the thousands of buyers and sellers of the stock were price takers. On a given day, they all must accept the stock price established by the market given. In June 2005, this price was about $25 per share. Sources: http://microsoft.com/msft/ and The Wall Street Journal, June 24, 2005.

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Perfectly Competitive Markets

Perfectly competitive market A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, (3) no barriers to new firms entering the market.

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A Perfectly Competitive Firm Cannot Affect the Market Price

Perfectly Competitive Markets

Price taker A buyer or seller that is unable to affect the market price.

A Perfectly Competitive Firm Faces a Horizontal Demand Curve

2 LEARNING OBJECTIVE

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How a Firm Maximizes Profit in a Perfectly Competitive Market

Profit Total revenue minus total cost. Profit = TR - TC

Dont Confuse the Demand Curve for Farmer Douglass Wheat with the Market Demand Curve for Wheat 6

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How a Firm Maximizes Profit in Perfectly Competitive Market

Revenue for a Firm in a Perfectly Competitive Market

Average revenue (AR) Total revenue divided by the number of units sold.
AR TR Q

so, AR

TR P Q P Q Q

Marginal revenue (MR) Change in total revenue from selling one more unit.
Change in total revenue TR Marginal Revenue , or MR Change in quantity Q

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How a Firm Maximizes Profit in a Perfectly Competitive Market

Revenue for a Firm in a Perfectly Competitive Market

NUMBER OF BUSHELS (Q) MARKET PRICE (PER BUSHEL) (P) TOTAL REVENUE (TR) AVERAGE REVENUE (AR) MARGINAL REVENUE (MR)

0 1 2 3 4 5 6 7 8 9 10

$4 4 4 4 4 4 4 4 4 4 4

$0 4 8 12 16 20 24 28 32 36 40

$4 4 4 4 4 4 4 4 4 4

$4 4 4 4 4 4 4 4 4 4

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How a Firm Maximizes Profit in a Perfectly Competitive Market

Revenue for a Firm in a Perfectly Competitive Market
QUANTITY (BUSHELS) (Q) TOTAL REVENUE (TR) TOTAL COSTS (TC) PROFIT (TR-TC) MARGINAL MARGINAL REVENUE COST (MR) (MC) $4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 $3.00 2.00 1.50 2.00 2.50 3.00 4.50 6.00 7.00 8.00

0 1 2 3 4 5 6 7 8 9 10

$0.00 4.00 8.00 12.00 16.00 20.00 24.00 28.00 32.00 36.00 40.00

$1.00 4.00 6.00 7.50 9.50 12.00 15.00 19.50 25.50 32.50 40.50

-$1.00 0.00 2.00 4.50 6.50 8.00 9.00 8.50 6.50 3.50 -0.50

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How a Firm Maximizes Profit in a Perfectly Competitive Market

The Profit-Maximizing Level of Output

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3 LEARNING OBJECTIVE

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Illustrating Profit or Loss on the Cost Curve Graph

Profit = (P x Q) TC
TC ( P Q) Profit Q Q Q

Or
Profit P ATC , Q

Profit = (P ATC)Q
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Showing a Profit on the Graph

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Determining Profit-Maximizing Price and Quantity

OUTPU T PER DAY 0 1 2 3 4 5 6 7 8 9

TOTA L COST $1.00 1.50 1.75 2.25 3.00 4.00 5.25 6.75 8.50 10.50

MARGIN AL COST $0.50 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00
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Illustrating When a Firm Is Breaking Even or Operating at a Loss

P > ATC, which means the firm makes a profit P = ATC, which means the firm breaks even (its total cost equals it total revenue) P < ATC, which means the firm experiences losses

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Remember that Firms Maximize Total Profit, Not Profit per Unit

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Losing Money in the Medical Screening Industry

Providing preventive medical scans turned out not to be a profitable business.

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4 LEARNING OBJECTIVE

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Produce or to Shut Down in the Short Run

In the short run a firm suffering losses has two choices:

Continue to produce

Stop production by shutting down temporarily

Sunk cost A cost that has already been paid and that cannot be recovered.

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The Supply Curve of the Firm in the Short Run

Shutdown point The minimum point on a firms average variable cost curve; if the price falls below this point, the firm shuts down production in the short run. 18

5 LEARNING OBJECTIVE

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Economic Profit and the Entry or Exit Decision

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Economic Profit and the Entry or Exit Decision

Economic profit A firms revenues minus all its costs, implicit and explicit. Economic loss The situation in which a firms total revenue is less than its total cost, including all implicit costs.

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Economic Profit and the Entry or Exit Decision

EXPLICIT COSTS
Water Wages Organic fertilizer Electricity Payment on bank loan IMPLICIT COSTS Foregone salary $30,000 Opportunity cost of the $100,000 she has invested in her $10,000 farm Total Cost $125,000
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$25,000 $35,000 $14,000 $5,000 $6,000

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Economic Profit and the Entry or Exit Decision

ECONOMIC PROFIT LEADS TO ENTRY OF NEW FIRMS
The Effect of Entry on Economic Profits

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Economic Profit and the Entry or Exit Decision

ECONOMIC LOSSES LEAD TO EXIT OF FIRMS

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Economic Profit and the Entry or Exit Decision

ECONOMIC LOSSES LEAD TO EXIT OF FIRMS
The Effect of Exit on Economic Losses (contd.)

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Long-Run Equilibrium in a Perfectly Competitive Market Long-run competitive equilibrium

The situation in which the entry and exit of firms have resulted in the typical firm just breaking even.

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The Long-Run Supply Curve in a Perfectly Competitive Market

Long-run supply curve A curve showing the relationship in the long run between market price and the quantity supplied.

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The Long-Run Supply Curve in a Perfectly Competitive Market

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6 LEARNING OBJECTIVE

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Perfect Competition and Efficiency

Productive Efficiency
Productive efficiency The situation in which a good or service is produced at the lowest possible cost.

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How Productive Efficiency Benefits Consumers

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Perfect Competition and Efficiency Allocative Efficiency Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them:
The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit. Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
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Allocative Efficiency

Allocative efficiency A state of the economy in which production reflects consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

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