Principles of Microeconomics Chapter 8 PDF

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 8 Perfect Competition Prepared by Ifeanyi Uzoka, Sheridan College  CHA...

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 8 Perfect Competition Prepared by Ifeanyi Uzoka, Sheridan College  CHAPTER 8 Perfect Competition Learning Objectives: 1. Distinguish among a firm, an industry, and a market 2. Explain what is meant by perfect competition and the market system 3. Use two approaches to explain how a firm might maximize its profits 4. Explain how to calculate a firm’s profit and loss and what is meant shutdown price © 2024 McGraw Hill 8-2  CHAPTER 8 Perfect Competition Learning Objectives: 5. Explain how both the firm’s and the industry’s supply curves are derived 6. Explain the cause and effect of the entry and exit of firms in an industry 7. Explain what the long-run supply is and how it is derived © 2024 McGraw Hill 8-3  LO1: Characteristics of Different Markets © 2024 McGraw Hill 8-4 Industry versus Markets Industry – A group of producers, all producing a similar product Market – The interaction of both producers and consumers © 2024 McGraw Hill 8-5  Market characteristics 2 ways in which markets differ – Types of products sold – Number of buyers and sellers interacting in the market Table 8.1 Characteristics of the Four Markets Number of Firms in the Industry Type of Many Few One Product Undifferentiated Identical Perfect Competition Monopoly Oligopoly Differentiate Monopolistic Differentiated d Competition Oligopoly © 2024 McGraw Hill 8-6  The Different Types of Markets Table 8.2 The Different Types of Markets Numbe Ease of Seller’s Type of Market r of Entry to Control Examples Product Sellers Market over Price Perfect Numero Commodities, such as Identical Easy None competition us wheat Monopolisti Differentiate Convenience stores, c Many Easy Low d restaurants competition Oligopoly: undifferenti Few Identical Difficult Moderate Oil refining, lumber ated Oligopoly: Differentiate Automobiles, soft differentiate Few Difficult Substantial d drinks d Very Public utilities, cable Monopoly One Unique Substantial difficult companies © 2024 McGraw Hill 8-7 Test Your Understanding In what type of market will you find the following types of firms/products? – Hairdressing salons – Industrial chemicals in Canada – Commercial breweries in Canada – World market for coffee – Rogers Cable in Ontario © 2024 McGraw Hill 8-8 Test Your Understanding In what type of market will you find the following types of firms/products? – Hairdressing salons - monopolistic competition – Industrial chemicals in Canada – Commercial breweries in Canada – World market for coffee – Rogers Cable in Ontario © 2024 McGraw Hill 8-9 Test Your Understanding In what type of market will you find the following types of firms/products? – Hairdressing salons - monopolistic competition – Industrial chemicals in Canada - undifferentiated oligopoly – Commercial breweries in Canada - differentiated oligopoly – World market for coffee - perfect competition © 2024 McGraw Hill 8-10 – LO2: Perfect Competition and the Market System © 2024 McGraw Hill 8-11  Perfect Competition Perfect Competition: A market in which all buyers and sellers are price takers – Conditions: – Many small buyers and sellers – No preferences shown (undifferentiated product) – Easy entry and exit by both buyers and sellers © 2024 McGraw Hill 8-12 Test Your Understanding In what ways is the stock market a good example of perfect competition? In what ways is it a bad example? © 2024 McGraw Hill 8-13 Test Your Understanding In what ways is the stock market a good example of perfect competition? A good example: Many (millions) of buyers and sellers, Products sold (shares in a company) are undifferentiated A great deal of information available about © 2024 McGraw Hill products 8-14 Test Your Understanding In what ways is the stock market a bad example of perfect A bad example: competition? Some buyers and sellers are big enough to affect prices There is not equal access to information (insider trading) There is not free entry into the market (need © 2024 McGraw Hill 8-15  LO3: The Competitive Industry and Firm © 2024 McGraw Hill 8-16 The Competitive Industry and Firm – In pure competition, a single firm has little effect on overall supply, so the market price becomes the firm’s demand and is constant – Demand is horizontal and the firm a price taker © 2024 McGraw Hill 8-17 Total, Average and Marginal Revenues Total Revenue – Total quantity sold (Q) times price (P) TR = Q XP Average Revenue – The amount of revenue received per unit sold AR = TR = Q X P = P Q McGraw Hill © 2024 Q 8-18 Total, Average and Marginal Revenues Marginal Revenue – The extra revenue derived from one more unit MR = Δ TR = Δ Q X P = P ΔQ ΔQ © 2024 McGraw Hill 8-19  Deriving Average and Marginal Revenue Table 8.3 Deriving Average and Marginal Revenue Total Average Marginal Output Price Revenue Revenue (AR) Revenue (MR) (TR) 0 $20 $0 $/ $/ 1 20 20 20 20 2 20 40 20 20 3 20 60 20 20 4 20 80 20 20 5 20 100 20 20 6 20 120 20 20 7 20 140 20 20 8 20 160 20 20 9 20 180 20 20 10 20 200 20 20 ― For competitive firms, Price = AR = MR © 2024 McGraw Hill 8-20  Revenue Curves Total revenue slopes up as more units are sold Average, marginal revenue and price are constant regardless of quantity sold © 2024 McGraw Hill 8-21  Profit and Output Total Profit Tπ = TR - TC – The difference between total revenue and total costs – Maximum profit occurs when TR-TC is greatest. Break-Even Output – The level of output at which the sales revenue of the firm just coversTR fixed and = TC variable costs, including normal profit. – There is ZERO economic © 2024 McGraw Hill profit. 8-22  Total Revenue, Costs and Profit Example Table 8.4 Total Revenue, Cost, and Profit for a Perfectly Competitive Producer Output Price (AR = Total Revenue Total Cost Total Profit (Q) MR) (TR) (TC) (Tπ) 0 $20 $0 $30 $−30 1 20 20 48 −28 2 20 40 58 −18 3 20 60 60 0 4 20 80 63 17 5 20 100 70 30 6 20 120 90 30 7 20 140 120 20 8 20 160 160 0 9 20 180 220 −40 ― Maximum20economic 10 profit 200 is where TR − TC is greatest. 300 −100 © 2024 McGraw Hill 8-23  Total Revenue, Costs and Profits Here, producing less than 3 units (or more than 8) results in a loss Break-even occurs at 3 and 8 units © 2024 McGraw Hill 8-24  Total Revenue, Costs and Profits Maximum profit occurs when the distance between TR and TC is at its Maximum © 2024 McGraw Hill 8-25  Marginal Approach to Profit Another approach to profit maximization – A firm maximizes its total profits by producing an output at which the MC = MR. If MR > MC  produce more If MR < MC  produce less To maximize total profit:  produce © 2024 McGraw Hill 8-26  Marginal Approach to Profit If MR > MC  produce more Average revenue and costs If MR < MC  produce less To maximize total profit:  produce up to where MR = MC © 2024 McGraw Hill 8-27  Marginal Cost and Marginal Revenue Example Table 8.5 Marginal Cost and Marginal Revenue Marginal Marginal Output Marginal Total Total Cost Revenue = Surplus/Defi (Q) Cost Profit/Loss Price cit 0 $30 $−30 1 48 $18 $20 $2 −28 2 58 10 20 10 −18 3 60 2 20 18 0 4 63 3 20 17 17 5 70 7 20 13 30 6 90 20 20 0 30 7 120 30 20 −10 20 8 160 40 20 −20 0 9 180 60 20 −40 −40 10 200 80 20 −60 −100 © 2024 McGraw Hill 8-28  Marginal Cost and Marginal Revenue Example Table 8.5 Marginal Cost and Marginal Revenue Marginal Marginal Output Marginal Total Total Cost Revenue = Surplus/Defi (Q) Cost Profit/Loss Price cit 0 $30 $−30 1 48 $18 $20 $2 −28 2 58 10 20 10 −18 3 60 2 20 18 0 4 63 3 20 17 17 5 70 7 20 13 30 6 90 20 20 0 30 7 120 30 20 −10 20 8 160 40 20 −20 0 9 180 60 20 −40 −40 10 200 80 20 −60 −100 © 2024 McGraw Hill 8-29  Marginal Cost and Marginal Revenue Example Table 8.5 Marginal Cost and Marginal Revenue Marginal Marginal Output Marginal Total Total Cost Revenue = Surplus/Defi (Q) Cost Profit/Loss Price cit 6 90 20 20 0 30 © 2024 McGraw Hill 8-30 Test Your Understanding Given the data for Marshall’s Meat Ltd., calculate total revenue and total profits at each Outputoutput. Price (P) TR Total Costs T∏ (Q) (TC) 0 50 40 1 50 135 2 50 180 3 50 220 4 50 230 5 50 250 6 50 280 7 50 350 8 50 450 © 2024 McGraw Hill 8-31 Test Your Understanding Given the data for Marshall’s Meat Ltd., calculate total revenue and total profits at each Outputoutput. Price (P) TR Total Costs T∏ (Q) (TC) 0 50 0 40 1 50 50 135 2 50 100 180 3 50 150 220 4 50 200 230 5 50 250 250 6 50 300 280 7 50 350 350 8 50 400 450 © 2024 McGraw Hill 8-32 Test Your Understanding Given the data for Marshall’s Meat Ltd., calculate total revenue and total profits at each Outputoutput. Price (P) TR Total Costs T∏ (Q) (TC) 0 50 0 40 -40 1 50 50 135 -85 2 50 100 180 -80 3 50 150 220 -70 4 50 200 230 -30 5 50 250 250 0 6 50 300 280 20 7 50 350 350 0 8 50 400 450 -50 © 2024 McGraw Hill 8-33 Test Your Understanding What are the break-even levels of output? Output Price (P) TR Total Costs T∏ (Q) (TC) 0 50 0 40 -40 1 50 50 135 -85 2 50 100 180 -80 3 50 150 220 -70 4 50 200 230 -30 5 50 250 250 0 6 50 300 280 20 7 50 350 350 0 8 50 400 450 -50 © 2024 McGraw Hill 8-34 Test Your Understanding What are the break-even levels of output? Output Price (P) TR Total Costs T∏ (Q) (TC) 0 50 0 40 -40 1 50 50 135 -85 2 50 100 180 -80 3 50 150 220 -70 4 50 200 230 -30 5 50 250 250 0 6 50 300 280 20 7 50 350 350 0 8 50 400 450 -50 © 2024 McGraw Hill 8-35 Test Your Understanding What is the profit-maximizing level of output? Output Price (P) TR Total Costs T∏ (Q) (TC) 0 50 0 40 -40 1 50 50 135 -85 2 50 100 180 -80 3 50 150 220 -70 4 50 200 230 -30 5 50 250 250 0 6 50 300 280 20 7 50 350 350 0 8 50 400 450 -50 © 2024 McGraw Hill 8-36 Test Your Understanding What is the profit-maximizing level of output? Output Price (P) TR Total Costs T∏ (Q) (TC) 0 50 0 40 -40 1 50 50 135 -85 2 50 100 180 -80 3 50 150 220 -70 4 50 200 230 -30 5 50 250 250 0 6 50 300 280 20 7 50 350 350 0 8 50 400 450 -50 © 2024 McGraw Hill 8-37 LO4: Profit, Loss & Shutdown Price for the Firm © 2024 McGraw Hill 8-38  Profit, loss and shutdown A firm can be facing: – Profit – Breakeven – Loss continue to produce at a loss temporarily shut down © 2024 McGraw Hill 8-39  Decision Making Different cost curves can be used to illustrate how different decisions are made by the firm. – the AVC curve is used to decide whether to produce at all or shut down – the MC curve is used to decide the best output, – the AC curve is used to determine the level of profit or loss. © 2024 McGraw Hill 8-40  Totals and Averages Knowing that maximum profit at MR = MC gives 6 units of output and a price of $20 (which is AR), we can see that: Total profit = (AR – AC ) x Q = ($20 - $15) x 6= $5 x 6 = $30 © 2024 McGraw Hill 8-41  Loss and Shutdown Would a firm willingly produce at a loss? – YES, if the losses from production are less than total fixed costs, the firm should continue to produce – NO, if the losses from production are more than total fixed costs, the firm should not continue to produce © 2024 McGraw Hill 8-42  Shutdown The aim of the firm must always be to cover its variable costs (at least), and if it cannot, it should shut down. Shutdown Price – The price that is just sufficient to cover a firm’s variable costs © 2024 McGraw Hill 8-43  Price and Average Cost Profitable Price - when Price is greater than (or above) Average Cost © 2024 McGraw Hill 8-44  Price and Average Cost Price Causing Loss − when Price is less than (or below) Average Cost © 2024 McGraw Hill 8-45  Price and Average Cost Shutdown Price − The price that is just able to cover a © 2024 McGraw Hill 8-46 Decisions Facing The Firm © 2024 McGraw Hill 8-47  Test Your Understanding 6. The accompanying graph shows the costs for a perfectly competitive firm. a) If the price is $120, what is the optimum output? Is there profit or loss? At $120, optimum output is 70 units. © 2024 McGraw Hill 8-48 Test Your Understanding b) What is the shutdown price? Shutdown at $100 (the minimum of AVC) © 2024 McGraw Hill 8-49  LO5: The Firm and The Industry Supply Curve © 2024 McGraw Hill 8-50  Deriving the Supply Curve To maximize profits, the firm produces where P = MC − At a price below AVC, it produces zero − The firm’s supply curve is thus the portion of its MC curve that lies above its AVC curve © 2024 McGraw Hill 8-51  The Industry’s Supply Curve The total supply for the whole industry (100 firms) is derived by adding up the supplies of each individual producer © 2024 McGraw Hill 8-52  LO6: Entry and Exit of Firms © 2024 McGraw Hill 8-53  Industry Demand and Supply In the short run the size of both the firm and the industry are fixed; In the long run, both are variable © 2024 McGraw Hill 8-54  The Effect of Entry of New Firms into an Industry − Initial equilibrium is at price P1 (point a in Graph B) − In the short run, firms are making economic profits at P1 (in Graph A) − In the long run, attracted by economic profits, new firms enter, increasing supply and reducing price to P2 (point b in Graph B) © 2024 McGraw Hill 8-55  The Effect of Entry of New Firms into an Industry cont’d − The industry now has more firms and higher output at point b, but the price drops and the firm’s output reduces to Q2 (zero economic profit) © 2024 McGraw Hill 8-56  The Effect of Exit of Firms from an Industry Initial equilibrium is at price P1 (point a in Graph A) In the short run firms are making economic losses at P1 (Graph B) In the long run, discouraged by economic losses, some firms exit, decreasing supply and increasing price to P2 (point b in Graph A) © 2024 McGraw Hill 8-57  The Effect of Exit of Firms from an Industry The industry now has fewer firms, lower output at point b, but the price rises and the firm’s output increases to Q2 (zero economic profit) © 2024 McGraw Hill 8-58  LO7: Long-Run Supply of the Industry © 2024 McGraw Hill 8-59  Long Run Supply of the Industry Increasing Cost Industry: If the prices of resources and products both rise as the industry expands Decreasing Cost Industry: If the prices of resources and products both fall as the industry expands Constant Cost Industry: If the prices of resources and products remain unchanged as the industry expands © 2024 McGraw Hill 8-60 Increasing, Decreasing and Constant Cost Industries In the long run, increases in demand increase supply A. If this increases costs, long run supply slopes up B. If this decreases costs, long run supply slopes down C. If costs remain unchanged, long run supply is flat © 2024 McGraw Hill 8-61  Test Your Understanding 10. Suppose that initially the market demand and supply for a product are as shown in the following graph. a) Now assume that the demand increases by 25 units at every price and, as a result, new firms enter, causing the supply to increase. However, since the costs of production also increase, the supply only increases by 10 units. Label the new curves D2 and S2. Identify the new equilibrium, labelled E2. What are the new price and quantity? © 2024 McGraw Hill 8-62  Test Your Understanding a) New equilibrium is at P = $6 and Q = 60 b) New equilibrium is at P = $8 and Q = 50 © 2024 McGraw Hill 8-63  CHAPTER 8 Key Concepts to Remember 1. Difference between a firm, industry, and market 2. Meaning of perfect competition and market system 3. How firms maximize profits 4. Calculation of profit, loss and meaning of shutdown price © 2024 McGraw Hill 8-64  CHAPTER 8 Key Concepts to Remember 5. Firm’s and industry’s supply curve 6. Impact of entry and exit of firms in an industry 7. Long-run supply curve and its derivation © 2024 McGraw Hill 8-65