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Chapter 7

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PERFECT COMPETITION
Market Structure is
Important for Two Reasons

It influences firm Behavior & Profitability


It Influences Economic Performance
Which Markets Perform Well
Which should be Regulated
We divide markets according to:
Number of Competitors
Barriers to Entry
Types of Products
Barriers to Entry
Firms High Medium None
1

Monopoly

Few

Oligopoly

Many

Perfect
Competition

BASICS OF SUPPLY & DEMAND

7.2

The competitive equilibrium occurs


at P = $25 and Q = 8 thousand shoes.
The increase (shift) in demand results in
a higher price and a greater output.
Price

Supply

Demand
$25

8
12
Pairs of Shoes

16

SUPPLY & DEMAND

7.3

The fall in the marginal cost of production


causes a favorable shift in supply and
a lower price accompanied by greater output.

Price

Supply

Demand
$25

8
12
Pairs of Shoes

16

PERFECT COMPETITION

7.4

Firm Behavior
Each firm is a price taker (MR = P).
Each firm sets its QF such that P = MC.
In long-run equilibrium,
price is bid down until:
P = MR = MC = ACMIN
Revenue
& Cost
per unit

MC

AC

P = $8

P = $6

QF

QF

Output

Perfect Competition:
Industry Outcome

7.5

Initial Equilibrium: P = $6 & Q = 200.


After an increase in demand, the
short-run result (before entry) is:
P = $8 & Q = 240.
The long-run result (after entry) is:
P = $6 & Q = 280.
D
Supply Curve
before Entry

$8
Supply Curve
after Entry

$6
$4

|
200 240

|
280 300

PRIVATE MARKET EFFICIENCY

7.6

Competitive Markets Provide the Right


Amounts of Goods and Services
that People Want and at Least Cost.
The Argument goes back to Adam Smiths
Invisible Hand Metaphor.
Well Sketch the Argument Starting with:
Individual Transactions and Building
up to Competitive Markets.

A DAY-CARE EXAMPLE

7.7

Parents of a Two-Year Old are Willing


to Pay $8 per hour for up to 10 hours
of Day Care per Week.
The Granny Down the Street will
provide Care for $4 per Hour.
Can the Parties bargain to a
mutually beneficial agreement?

Yes

What if a second couple is


willing to pay $10 per hour?
$10 -

Consumer Surplus
$20 per Week

8 -

Couples
Maximum
Value

Consumer Surplus
$20
per Week
Producer
Profit
$40 perProfit
Week
Producer

P = $6 -

$20 per Week

4 -

Grannys
Cost

2 0
0

10

12

7.8

A COMPETITIVE
DAY-CARE MARKET

All Buyers Pay Same Price.


12 10 -

Regional
Day-Care
Demand
MB

High Valuers Obtain Day Care.


Low-Cost Firms Supply
Day Care.
The Competitive Quantity
is Efficient.

8 6 -

Grandmothers
4 -

Day-Care
Supply
MC

$2.50
2 - Store-Bought Day Care
0

10

12

14

QC = 9.5

TRADE BARRIERS &


DEADWEIGHT LOSS

7.9

US Demand

US Supply

$15

DWL

World Price

$12.50

under Free Trade

US Imports

15

20

25

Deadweight loss under trade prohibition


is greater than w/ a $1.50 tariff.
US Demand

US Supply

$15
$14
$12.50

DWL

DWL

Imports

18

22

World Price
under Free Trade