Week 8 Class Perfect Competition PDF

Perfect Competition ECON 1000: Microeconomics for Managers Week 8 Professor Irene Henriques Learning outcomes:  Define perfect competition  Explain how price and output are determined in perfect competition  Explain why firms enter and leave a market  Predict the effects of technol...

Perfect Competition ECON 1000: Microeconomics for Managers Week 8 Professor Irene Henriques Learning outcomes:  Define perfect competition  Explain how price and output are determined in perfect competition  Explain why firms enter and leave a market  Predict the effects of technological change in a competitive market (time permitting) © 2022 Pearson Education  What Is Perfect Competition? Perfect competition is a market in which  Many firms sell identical products 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. © 2025 Pearson Canada  What Is Perfect Competition? Price Takers In perfect competition, each firm is a price taker. A price taker is a firm that cannot influence the price of a good or service. No single firm can influence the price—it must “take” the equilibrium market price. Each firm’s output is a perfect substitute for the output of the other firms, so the demand for each firm’s output is perfectly elastic. © 2025 Pearson Canada  The Revenue of a Competitive Firm A firm in a competitive market tries to maximize profit, which equals total revenue minus total cost. P : Price Q : Quantity  TR : Total revenue Average revenue tells us how much revenue a firm receives for the typical unit sold. Average revenue (AR) is the total revenue divided by the quantity sold. © 2025 Pearson Canada THE REVENUE OF A COMPETITIVE FIRM (CONT’D)  Marginal revenue (MR) is the change in total revenue from an additional unit sold.  For competitive firms, marginal revenue equals the price of the good.  What Is Perfect Competition? Figure 11.1 illustrates a firm’s revenue concepts. Part (a) shows that market demand and market supply determine the market price that the firm must take. © 2025 Pearson Canada  What Is Perfect Competition? With the market price of $25 a sweater, the firm sells 9 sweaters and the total revenue is $225 a day. Figure 11.1(b) shows the firm’s total revenue curve (TR). © 2025 Pearson Canada  What Is Perfect Competition? The firm can sell any quantity it chooses at the market price, so marginal revenue equals the market price of $25. © 2025 Pearson Canada  What Is Perfect Competition? Figure 11.1(c) shows the marginal revenue curve (MR), which is the demand curve for the firm’s product. © 2025 Pearson Canada  What Is Perfect Competition? The demand for a firm’s product is perfectly elastic because one firm’s sweater is a perfect substitute for the sweater of another firm. The market demand is not perfectly elastic because a sweater is a substitute for some other good. © 2025 Pearson Canada  The Competitive Firm’s Decisions A perfectly competitive firm’s 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 enter or exit a market We start by looking at the firm’s output decision. © 2025 Pearson Canada  The Firm’s Output Decision 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 firm’s total revenue and total cost curves. Figure 11.2 on the next slide looks at these curves along with the firm’s total profit curve. © 2025 Pearson Canada  The Firm’s Output Decision Part (a) shows the total revenue, TR, curve. Part (a) also shows the total cost curve, TC. Total revenue minus total cost is economic profit (or loss), shown by the curve EP in part (b). © 2025 Pearson Canada  The Firm’s Output Decision At low output levels, the firm incurs an economic loss—it can’t cover its fixed costs. At intermediate output levels, the firm makes an economic profit. © 2025 Pearson Canada  The Firm’s Output Decision At high output levels, the firm again incurs an economic loss—now the firm faces steeply rising costs because of diminishing returns. The firm maximizes its economic profit when it produces 9 sweaters a day. © 2025 Pearson Canada  The Firm’s Output Decision Marginal Analysis and Supply Decision The firm can use marginal analysis to determine the profit-maximizing 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 11.3 on the next slide shows the marginal analysis that determines the profit-maximizing output. © 2025 Pearson Canada  The Firm’s 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. © 2025 Pearson Canada  Temporary Shutdown Decision If the firm makes an economic loss, it must decide whether 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 firm’s loss. © 2025 Pearson Canada  Loss Comparisons The firm’s loss equals total fixed cost (TFC) plus total variable cost (TVC) minus total revenue (TR). Economic loss = TFC + TVC  TR = TFC + (AVC  P) x 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 TFC. This economic loss is the largest that the firm must bear. © 2025 Pearson Canada  The Shutdown Point A firm’s shutdown point is the price and quantity at which it is indifferent between producing the profit-maximizing quantity and shutting down. The shutdown point is at minimum AVC. This point is the same point at which the MC curve crosses the AVC curve. At the shutdown point, the firm is indifferent between producing and shutting down temporarily. At the shutdown point, the firm incurs a loss equal to total fixed cost (TFC). © 2025 Pearson Canada  The Firm’s Output Decision Figure 11.4 shows the shutdown point. Minimum AVC is $17 a sweater. At $17 a sweater, the profit-maximizing output is 7 sweaters a day. The firm incurs a loss equal to the red rectangle. © 2025 Pearson Canada  The Firm’s 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 some of its fixed cost. It incurs a loss that is less than TFC. © 2025 Pearson Canada  Classroom Activity A Profitable Opportunity?  As a recent postsecondary graduate, you have landed a job in production management for Universal Clones Inc. You are responsible for the entire company on weekends.  Your costs are shown below. Quantity Average Total Cost 500 200 501 201  Your current level of production is 500 units. All 500 units have been ordered by  Classroom Activity A Profitable Opportunity? (cont’d)  The phone rings. It’s a new customer who wants to buy 1 unit of your product. This means you would have to increase production to 501 units. Your new customer offers you $450 to produce the extra unit. A. Should you accept this offer? B.What is the net change in the firm’s profit?  The Firm’s Supply Curve A perfectly competitive firm’s supply curve shows how the firm’s profit-maximizing output varies as the market price varies, other things remaining the same. Because the firm produces the output at which marginal cost equals marginal revenue, and because marginal revenue equals price, the firm’s supply curve is linked to its marginal cost curve. But at a price below the shutdown point, the firm produces nothing. © 2025 Pearson Canada  The Firm’s Decision Figure 11.5 shows how the firm’s supply curve is constructed. If price equals minimum AVC, $17 a sweater, the firm is indifferent between producing nothing and producing at the shutdown point, T. © 2025 Pearson Canada  The Firm’s Decision If the price is $25 a sweater, the firm produces 9 sweaters a day, the quantity at which P = MC. If the price is $31 a sweater, the firm produces 10 sweaters a day, the quantity at which P = MC. The blue curve in part (b) traces the firm’s short-run supply curve. © 2025 Pearson Canada  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 firm’s plant and the number of firms remain the same. Figure 11.6 (on the next slide) shows the market supply curve of sweaters, when there are 1,000 sweater-producing firms identical to Campus Sweater. © 2025 Pearson Canada  Market Supply in the Short Run Figure 11.6 shows the market supply curve. At the shutdown price ($17), some firms will produce the shutdown quantity (7 sweaters) and others will produce zero. At this price, the market supply curve is horizontal. © 2025 Pearson Canada  Market Supply in the Short Run Short-Run Equilibrium Short-run market supply and market demand determine the market price and output. Figure 11.7 shows a short-run equilibrium. © 2025 Pearson Canada  A Change in Demand An increase in demand brings a rightward shift of the market demand curve: The price rises and the quantity increases. A decrease in demand brings a leftward shift of the market demand curve: The price falls and the quantity decreases. © 2025 Pearson Canada  Profits and Losses in the Short Run Maximum profit is not always a positive economic profit. To see if a firm is making a profit or incurring a loss compare the firm’s ATC at the profit- maximizing output with the market price. Figure 11.8 on the next slide shows the three possible profit outcomes. © 2025 Pearson Canada  Profits and Losses in the Short Run In part (a) price equals average total cost and the firm makes zero economic profit (breaks even). © 2025 Pearson Canada  Profits and Losses in the Short Run In part (b), price exceeds average total cost and the firm makes a positive economic profit. © 2025 Pearson Canada  Profits and Losses in the Short Run In part (c) price is less than average total cost and the firm incurs an economic loss—economic profit is negative. © 2025 Pearson Canada  Profits and Losses in the Short Run In short-run equilibrium, a firm might make an economic profit, break even, or incur an economic loss. In long-run equilibrium, firms break even because firms can enter or exit the market. © 2025 Pearson Canada  Output, Price, and Profit in the Long Run: Entry & Exit 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 11.9 shows the effects of entry and exit. © 2025 Pearson Canada  A Closer Look at Entry When the market price is $25 a sweater, firms in the market are making economic profit. © 2025 Pearson Canada  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. © 2025 Pearson Canada  Output, Price, and Profit in the Long Run Firms enter as long as firms are making economic profits. In the long run, the market price falls until firms are making zero economic profit. © 2025 Pearson Canada  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. © 2025 Pearson Canada  Output, Price, and Profit in the Long Run Firms have an incentive to exit the market. When they do, the market supply decreases and the market price rises. © 2025 Pearson Canada  Output, Price, and Profit in the Long Run Firms exit as long as firms are incurring economic losses. In the long run, the price continues to rise until firms make zero economic profit. © 2025 Pearson Canada  A Decrease in Market Demand A decrease in market demand shifts the market demand curve leftward. The price falls and the quantity decreases. Starting from long-run equilibrium, firms incur economic losses. Figure 11.10 illustrates the effects of a decrease in demand. © 2025 Pearson Canada  A Decrease in Market Demand The market demand curve shifts leftward, the market price falls, and each firm decreases the quantity it produces. © 2025 Pearson Canada  A Decrease in Market Demand The market price is now below the firm’s minimum average total cost, so each firm incurs an economic loss. © 2025 Pearson Canada  A Decrease in Market Demand Economic loss induces some firms to exit the market, which decreases the market supply and the price starts to rise. © 2025 Pearson Canada  A Decrease in Market Demand As the price rises, the quantity produced by all firms starts to increase and each firm’s economic loss starts to fall. © 2025 Pearson Canada  A Decrease in Market Demand Eventually, enough firms have exited for the supply and decreased demand to be in balance and firms make zero economic profit. Firms no longer exit the market. © 2025 Pearson Canada  A Decrease in Market Demand 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. © 2025 Pearson Canada  Technological Advances Change Supply Starting from a long-run equilibrium, when a new technology becomes available that lowers production costs, the first firms to use it make economic profit. But as more firms begin to use the new technology, market supply increases and the price falls. Figure 11.11 illustrates the effects of an increase in supply. © 2025 Pearson Canada  Technological Advances Change Supply Part (a) shows the market. Part (b) shows a firm using the original old technology. Firms are making zero economic profit. © 2025 Pearson Canada  Technological Advances Change Supply When a new technology becomes available, the ATC and MC curves shift downward. Firms that use the new technology make economic profit. © 2025 Pearson Canada  Technological Advances Change Supply Economic profit induces some new-technology firms to enter the market. The market supply increases and the price starts to fall. © 2025 Pearson Canada  Technological Advances Change Supply With the lower price, old-technology firms incur economic losses. Some exit the market; others switch to the new technology. © 2025 Pearson Canada  Technological Advances Change Supply Eventually all firms are using new technology. The market supply has increased and firms are making zero economic profit. © 2025 Pearson Canada Next week – Monopoly READ: C H A P TER 1 2 – MI CH AEL PAR K I N AND ROBI N BADE ( 2 0 2 5 ). MI CROE CONOMI C S : CANADA I N T HE GL OBAL ENV I RONMEN T , PEARSON CANADA.