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1、CHAPTER,1,Airlines and automobile producers are facing tough times: Prices are being slashed to drive sales and profits are turning into losses. Workers have been laid off temporarily or let go permanently. What determines the firms price and profit? Why do firms sometimes stop producing and tempora
2、rily lay off their workers? To study competitive markets, we are going to build a model of a market in which competition is as fierce and extreme as. We call this situation “perfect competition.”,What Is Perfect Competition?,Perfect competition is an industry in which Many firms sell identical produ
3、cts to many buyers. There are no restrictions to entry into the industry. Established firms have no advantages over new ones. Sellers and buyers are well informed about prices.,How Perfect Competition Arises Perfect competition arises: When firms minimum efficient scale is small relative to market d
4、emand so there is room for many firms in the industry. And when each firm is perceived to produce a good or service that has no unique characteristics, so consumers dont care which firm they buy from.,What Is Perfect Competition?,Price Takers In perfect competition, each firm is a price taker. A pri
5、ce taker is a firm that cannot influence the price of a good or service. No single firm can influence the priceit must “take” the equilibrium market price. Each firms output is a perfect substitute for the output of the other firms, so the demand for each firms output is perfectly elastic.,What Is P
6、erfect Competition?,Economic Profit and Revenue The goal of each firm is to maximize economic profit, which equals total revenue minus total cost. Total cost is the opportunity cost of production, which includes normal profit. A firms total revenue equals price, P, multiplied by quantity sold, Q, or
7、 P Q. A firms marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold.,What Is Perfect Competition?,Figure 12.1 illustrates a firms revenue concepts. Part (a) shows that market demand and market supply determine the market price that the firm must t
8、ake.,What Is Perfect Competition?,Figure 12.1(b) shows the firms total revenue curve (TR)the relationship between total revenue and quantity sold.,What Is Perfect Competition?,Figure 12.1(c) shows the marginal revenue curve (MR). The firm can sell any quantity it chooses at the market price, so marg
9、inal revenue equals price and the demand curve for the firms product is horizontal at the market price.,What Is Perfect Competition?,The demand for a firms product is perfectly elastic because one firms sweater is a perfect substitute for the sweater of another firm. The market demand is not perfect
10、ly elastic because a sweater is a substitute for some other good.,What Is Perfect Competition?,A perfectly competitive firms goal is to make maximum economic profit, given the constraints it faces. So the firm must decide: 1. How to produce at minimum cost 2. What quantity to produce 3. Whether to e
11、nter or exit a market We start by looking at the firms output decision.,What Is Perfect Competition?,Profit-Maximizing Output A perfectly competitive firm chooses the output that maximizes its economic profit. One way to find the profit-maximizing output is to look at the firms the total revenue and
12、 total cost curves. Figure 12.2 on the next slide looks at these curves along with the firms total profit curve.,The Firms Output Decision,Part (a) shows the total revenue, TR, curve.,Part (a) also shows the total cost curve, TC, which is like the one in Chapter 110. Total revenue minus total cost i
13、s economic profit (or loss), shown by the curve EP in part (b).,The Firms Output Decision,At low output levels, the firm incurs an economic lossit cant cover its fixed costs.,At intermediate output levels, the firm makes an economic profit.,The Firms Output Decision,At high output levels, the firm a
14、gain incurs an economic lossnow the firm faces steeply rising costs because of diminishing returns.,The firm maximizes its economic profit when it produces 9 sweaters a day.,The Firms Output Decision,Marginal Analysis and Supply Decision The firm can use marginal analysis to determine the profit-max
15、imizing output. Because marginal revenue is constant and marginal cost eventually increases as output increases, profit is maximized by producing the output at which marginal revenue, MR, equals marginal cost, MC. Figure 12.3 on the next slide shows the marginal analysis that determines the profit-m
16、aximizing output.,The Firms Output Decision,If MR MC, economic profit increases if output increases.,If MR MC, economic profit decreases if output increases.,If MR = MC, economic profit decreases if output changes in either direction, so economic profit is maximized.,The Firms Output Decision,Tempor
17、ary Shutdown Decision If the firm makes an economic loss it must decide to exit the market or to stay in the market. If the firm decides to stay in the market, it must decide whether to produce something or to shut down temporarily. The decision will be the one that minimizes the firms loss.,The Fir
18、ms Output Decision,Loss Comparison The firms loss equals total fixed cost (TFC) plus total variable cost (TVC) minus total revenue (TR). Economic loss = TFC + TVC TR = TFC + (AVC P) Q If the firm shuts down, Q is 0 and the firm still has to pay its TFC. So the firm incurs an economic loss equal to T
19、FC. This economic loss is the largest that the firm must bear.,The Firms Output Decision,A firms shutdown point is the price and quantity at which it is indifferent between producing and shutting down. This point is where AVC is at its minimum. It is also the point at which the MC curve crosses the
20、AVC curve. At the shutdown point, the firm is indifferent between producing and shutting down temporarily. The firm incurs a loss equal to TFC from either action.,The Firms Output Decision,Figure 12.4 shows the shutdown point. Minimum AVC is $17 a sweater. If the price is $17, the profit-maximizing
21、output is 7 sweaters a day. The firm incurs a loss equal to the red rectangle.,The Firms Output Decision,If the price of a sweater is between $17 and $20.14, the firm produces the quantity at which marginal cost equals price. The firm covers all its variable cost and at least part of its fixed cost.
22、 It incurs a loss that is less than TFC.,The Firms Output Decision,The Firms Supply Curve A perfectly competitive firms supply curve shows how the firms profit-maximizing output varies as the market price varies, other things remaining the same. Because the firm produces the output at which marginal
23、 cost equals marginal revenue, and because marginal revenue equals price, the firms supply curve is linked to its marginal cost curve. But at a price below the shutdown point, the firm produces nothing.,The Firms Output Decision,Figure 12.5 shows how the firms supply curve is constructed. If price e
24、quals minimum AVC, $17 in this example, the firm is indifferent between producing nothing and producing at the shutdown point, T.,The Firms Decision,If the price is $25, the firm produces 9 sweaters a day, the quantity at which P = MC. If the price is $31, the firm produces 10 sweaters a day, the qu
25、antity at which P = MC. The blue curve in part (b) traces the firms short-run supply curve.,The Firms Decisions,Market Supply in the Short Run The short-run market supply curve shows the quantity supplied by all firms in the market at each price when each firms plant and the number of firms remain t
26、he same.,Output, Price, and Profit in the Short Run,Figure 12.6 shows the supply curve for a market that has 1,000 firms like Campus Sweaters. The quantity supplied by the market at any given price is the sum of the quantities supplied by all the firms in the market at that price.,Output, Price, and
27、 Profit in the Short Run,At a price equal to minimum AVC, the shutdown price, some firms will produce the shutdown quantity and others will produces zero. The market supply curve is perfectly elastic.,Output, Price, and Profit in the Short Run,Short-Run Equilibrium Short-run market supply and market
28、 demand determine the market price and output. Figure 12.7 shows a short-run equilibrium.,Output, Price, and Profit in the Short Run,A Change in Demand An increase in demand bring a rightward shift of the market demand curve: The price rises and the quantity increases. A decrease in demand bring a l
29、eftward shift of the market demand curve: The price falls and the quantity decreases.,Output, Price, and Profit in the Short Run,Profits and Losses in the Short Run Maximum profit is not always a positive economic profit. To determine whether a firm is making an economic profit or incurring an econo
30、mic loss, we compare the firms average total cost at the profit-maximizing output with the market price. Figure 12.8 on the next slide shows the three possible profit outcomes.,Output, Price, and Profit in the Short Run,In part (a) price equals average total cost and the firm makes zero economic pro
31、fit (breaks even).,Output, Price, and Profit in the Short Run,In part (b), price exceeds average total cost and the firm makes a positive economic profit.,Output, Price, and Profit in the Short Run,In part (c) price is less than average total cost and the firm incurs an economic losseconomic profit
32、is negative.,Output, Price, and Profit in the Short Run,In short-run equilibrium, a firm may make an economic profit, break even, or incur an economic loss. Only one of them is a long-run equilibrium because firms can enter or exit the market.,Output, Price, and Profit in the Long Run,Entry and Exit
33、 New firms enter an industry in which existing firms make an economic profit. Firms exit an industry in which they incur an economic loss. Figure 12.8 shows the effects of entry and exit.,Output, Price, and Profit in the Long Run,A Closer Look at Entry When the market price is $25 a sweater, firms i
34、n the market are making economic profit.,Output, Price, and Profit in the Long Run,New firms have an incentive to enter the market. When they do, the market supply increases and the market price falls.,Output, Price, and Profit in the Long Run,Firms enter as long as firms are making economic profits
35、. In the long run, the market supply increases, the market price falls and firms make zero economic profit.,Output, Price, and Profit in the Long Run,A Closer Look at Exit When the market price is $17 a sweater, firms in the market are incurring economic loss.,Output, Price, and Profit in the Long R
36、un,Firms have an incentive to exit the market. When they do, the market supply decreases and the market price rises.,Output, Price, and Profit in the Long Run,Firms exit as long as firms are incurring economic losses. In the long run, the market supply decreases, the market price rises until firms m
37、ake zero economic profit.,Output, Price, and Profit in the Long Run,Changing Tastes and Advancing Technology,A Permanent Change in Demand A decrease in demand shifts the market demand curve leftward. The price falls and the quantity decreases. Figure 12.10 illustrates the effects of a permanent decr
38、ease in demand when the market is in long-run equilibrium.,A decrease in demand shifts the market demand curve leftward. The market price falls, and each firm decreases the quantity it produces.,Changing Tastes and Advancing Technology,The market price is now below each firms minimum average total c
39、ost, so firms incur economic losses.,Changing Tastes and Advancing Technology,Economic losses induce some firms to exit in the long run, which decreases the market supply and the price starts to rise.,Changing Tastes and Advancing Technology,As the price rises, the quantity produced by all firms con
40、tinues to decrease as more firms exit, but each firm remaining in the market starts to increase its quantity.,Changing Tastes and Advancing Technology,A new long-run equilibrium occurs when the price has risen to equal minimum average total cost. Firms make zero economic profits, and firms no longer
41、 exit the market.,Changing Tastes and Advancing Technology,The main difference between the initial and new long-run equilibrium is the number of firms in the market. Fewer firms produce the equilibrium quantity.,Changing Tastes and Advancing Technology,A permanent increase in demand has the opposite
42、 effects to those just described and shown in Figure 12.10. A permanent increase in demand shifts the demand curve rightward. The price rises and the quantity increases. Economic profit induces entry, which increases short-run supply and shifts the short-run market supply curve rightward. As the mar
43、ket supply increases, the price falls and the market quantity continues to increase.,Changing Tastes and Advancing Technology,With a falling price, each firm decreases its output as it moves along its marginal cost curve (supply curve). A new long-run equilibrium occurs when the price has fallen to
44、equal minimum average total cost. Firms make zero economic profit, and firms have no incentive to enter the market. The main difference between the initial and new long-run equilibrium is the number of firms. In the new equilibrium, a larger number of firms produce the equilibrium quantity.,Changing
45、 Tastes and Advancing Technology,External Economics and Diseconomies The change in the long-run equilibrium price following a permanent change in demand depends on external economies and external diseconomies. External economies are factors beyond the control of an individual firm that lower the fir
46、ms costs as the industry output increases. External diseconomies are factors beyond the control of a firm that raise the firms costs as industry output increases.,Changing Tastes and Advancing Technology,In the absence of external economies or external diseconomies, a firms costs remain constant as
47、the market output changes. Figure 12.11 illustrates the three possible cases and shows the long-run market supply curve. The long-run market supply curve shows how the quantity supplied in a market varies as the market price varies after all the possible adjustments have been made, including changes
48、 in each firms plant and the number of firms in the market.,Changing Tastes and Advancing Technology,Figure 12.11(a) shows that in the absence of external economies or external diseconomies, an increase in demand does not change the price in the long run. The long-run market supply curve LSA is hori
49、zontal.,Changing Tastes and Advancing Technology,Figure 12.11(b) shows that when external diseconomies are present, an increase in demand brings a higher price in the long run. The long-run market supply curve LSB is upward sloping.,Changing Tastes and Advancing Technology,Figure 12.11(c) shows that when external economies are present, an increase in demand brings a lower price in the long run. The long-run market supply curve LSC is downward sloping.,Changing Tastes and Advancing Technology,Technological Change New technologies are constantly discovered that lower costs. A new technology en