Chapter 9...

Price and Output Under Perfect Competition

Figure 9.1
Price Determination in the Market Period With the quantity supplied fixed at 350, the market supply curve of the commodity is S. With D as the market demand curve, the equilibrium price is $35. At prices higher than $35, there will be unsold quantities, and this will cause the price to fall to the equilibrium level. At prices below $35, the quantity demanded exceeds the quantity supplied, and the price will be bid up to $35. With D as the demand curve, P = $50. With D, P = $20.

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Figure 9.2
Short-Run Equilibrium of the Firm: Total Approach The STC curve in the top panel is that of Figure 8.1. The TR curve is a straight line through the origin with slope of P = $35. At Q = 0, TR = 0 and STC = $30, so that total profits are $30 and equal the firms TFC (see the bottom panel). At Q = 1, TR = $35 and STC = $50, so that total profits are $15. At Q = 1.5, TR = STC = $52.50, and total profits are zero. This is the break-even point. Between Q = 1.5 and Q = 5, TR exceeds STC and the firm earns (positive) economic profits. Total profits are greatest at $31.50 when Q = 3.5 (and the TR and the STC curves are parallel). At Q = 5, TR = STC = $175 so that total profits are zero (points T and T). At Q greater than 5, TR is smaller than STC and the firm incurs a loss.

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Table 9.1

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Figure 9.3
Short-Run Equilibrium of the Firm: Marginal Approach The demand curve facing the firm (d) is horizontal or infinitely elastic at the given price of P = $35. Since P is constant, marginal revenue (MR) equals P. The firm maximizes total profits where P = MR = MC, and MC is rising. This occurs at Q = 3.5 (point E). At Q = 3.5, P = $35 and ATC = $26. Therefore, profit per unit is $9 (EE), and total profits are $31.50 (shaded rectangle EE AB).

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Table 9.2

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Figure 9.4
Profit Maximization or Loss Minimization At P = $20, the best level of output of the firm is 2.75 units (point F, where P = MR = MC, and MC is rising). At Q = 2.75, average total cost (ATC) exceeds P and the firm will incur a loss of FF (about $5.50) per unit, and a total loss equal to rectangle FFNR (about $15). If, however, the firm were to shut down, it would incur the greater loss of $30 equal to its total fixed costs (the area of the larger rectangle FFGR). The shut down point (Z ) is at P = AVC.

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Figure 9.5
Short-Run Supply Curve of the Firm and Industry The left panel reproduces the firms MC curve above point Z (the shut down point) from Figure 8.4. This is the perfectly competitive firms shortrun supply curve s. For example, at P = $25, Q = 3 (point C); at P = $35, Q = 3.5 (point E); at P = $50, Q = 4 (point T). The right panel shows the industrys short-run supply curve on the assumption that there are 100 identical firms in the industry and input prices are constant. This is given by the MC = S curve. Thus, at P = $25, Q = 300 (point C*); at P = $35, Q = 350 (point E*); at P = $50, Q = 400 (point T*).

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Figure 9.6
The Supply Curve of Oil from Tar Sands The supply curve of oil from tar sands estimated in 1978 (S) roses gently up to 16 million barrels per day, where it becomes vertical. The actual supply curve S in 1984 showed much higher costs per barrel, while actual supply curve S in 2002 shows production costs to be about $9 per barrel in Alberta, Canada, and rising very gently as a result of major mining and extraction breakthroughs.

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Table 9.3

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Figure 9.7
The Short-Run World Supply Curve of Copper The short-run world supply curve of copper is obtained by summing up horizontally the marginal cost curve of the various countries. The shortrun world supply curve of copper slopes up as countries facing higher marginal costs of production are included.

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Figure 9.8
Short-Run Equilibrium of the Firm and Industry With S (from Figure 9.5) and D in the right panel, P = $35 and Q = 350 (point E*), and the perfectly competitive firm would produce 3.5 units (point E in the left panel, as in Figure 9.3). If D shifted up to D, P = $50 and Q = 400 (point T*), and the firm would produce 4 units of output (point T in the left panel).

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Figure 9.9
Long-Run Equilibrium of the Firm At P = MR = $35, the firm is in short-run equilibrium at point E (as in Figure 9.3). In the long run, the firm can increase its profits by producing at point J, where P or MR = LMC (and LMC is rising), and operating plant SATC5 at point J. In the long-run, the firm will make profits of $22 (JJ) per unit and $286 in total ($22 times 13 units of output). Since at point J, P = MR = SMC = LMC, the firm is also in short-run equilibrium.

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Figure 9. 10
Long-Run Equilibrium of the Industry and Firm The industry (in the right panel) and the firm (in the left panel) are in long-run equilibrium at point H, where P = MR = SMC = LMC = SATC = LAC = $10. The firm produces at the lowest point on its LAC curve (operating optimal plant SATC4 at point H) and earns zero profits.

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Figure 9.11
Constant Cost Industry Point H is the original long-run equilibrium point of the industry and firm. An increase in D to D results in P = $20, and all firms earn economic profits. As more firms enter the industry, S shifts to S and P = $10 if input prices remain constant. By joining points H and H in the right panel, we derive horizontal long-run supply curve LS for the (constant cost) industry.

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Figure 9.12
Increasing Cost Industry Point H is the original long-run equilibrium point of the industry and firm. An increase in D to D results in P = $20 and all firms earn economic profits. As more firms enter the industry, S shifts to S and P = $15 if input prices rise. By joining points H and H in the right panel, we derive positively sloped long-run supply curve LS for the (increasing cost) industry.

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Figure 9.13
Decreasing Cost Industry Points H and H are the same as in the preceding two figures. Starting from point H, as more firms enter the industry, S shifts to S and P = $5 if input prices fall. By joining points H and H in the right panel, we derive the negatively sloped long-run supply curve LS for the (decreasing cost) industry.

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Figure 9.14
Consumption, Production, and Imports Under Free Trade In the absence of trade, equilibrium is at point E, where Dx and Sx intersect, so that Px = $5 and Qx = 400. With free trade at the world price of Px = $3, domestic consumers purchase IR = 600X, of which IK = 200X are produced domestically and KR = 400X are imported.

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Figure 9.15
Producer Surplus At Px = $5 the firm produces 4X (point E). Since the marginal cost is $2 on the first unit of X produced, the firm receives a surplus of $3 (given by the area of the first shaded rectangle). With MCx = $3 on the second unit of X, producer surplus is $2 (the area of the second shaded rectangle). With MCx = $4 on the third unit, producer surplus is $1 (the area of the third shaded rectangle). With MCx = $5 on the fourth unit, producer surplus is zero. Total producer surplus on 4X is $6. If commodity X were infinitesimally divisible, total producer surplus would be $8 (the area of triangle BEC).

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Figure 9.16
The Efficiency of Perfect Competition Expanding output from 300X to 400X increases consumers plus producers surplus by HEJ = $100. Expanding output past the competitive equilibrium output of 400X reduces the total surplus, because the marginal benefit to consumers is less than the marginal cost of producers. Thus, consumers plus producers surplus is maximized when a perfectly competitive market is in equilibrium.

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Figure 9.17
Welfare Effects of an Excise Tax With Dx and Sx, equilibrium is at point E at which Px = $5 and Qx = 400. A tax of $2 per unit on commodity X shifts Sx up to S and defines new equilibrium point H at x which Px = $6 to consumers, Qx = 300, and producers receive a net price of $4 per unit. The loss of consumers surplus is LHEB = $350, the loss of producers surplus is BEJN = $350, for a combined loss of LHEJN = $700. Since tax revenues are LHJN = $600 ($2 per unit on 300 units), there is a deadweight loss of HEJ = $100.

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Figure 9.18
Effects of an Import Tariff Dx and Sx represent the domestic market demand and supply curves of commodity X. At the free trade price Px = $3, domestic consumers purchase IR = 600X, of which IK = 200X are produced domestically and KR = 400X are imported. With a $1 import tariff, Px to domestic consumers rises to $4. At Px = $4, domestic consumers purchase NU = 500X, of which NJ = 300X are produced domestically and JU = 200X are imported. Thus, the consumption effect of the tariff is RW = 100X, the production effect is KV = 100X, the trade effect is RW + KV = 200X, and the revenue effect is JUWV = $200. Consumers surplus declines by NURI = $550, of which NJKI = $250 represents an increase in producers surplus, JUWV = $200 is the tariff revenue, and URW = $50 plus JKV = $50 represents the deadweight loss of the tariff.

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Unnumbered Table 9.1

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Figure 9.19
The Foreign Exchange Market and the Dollar Exchange Rate The vertical axis measures the dollar price of euros (R = $/_), and the horizontal axis measures the quantity of euros. Under a flexible exchange rate system, the equilibrium exchange rate is R = 1 and the equilibrium quantity of euros bought and sold is _ 300 million per day. This is given by point E, at which the U.S. demand and supply curves for euros intersect.

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Table 9.4

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