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Perfect Competition
1
Market Structure Continuum
PureCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
FOUR MARKET MODELS
Characteristics of Pure Competition:
• Many small firms• Identical products (perfect substitutes)• Firms are “Price Takers”• Easy for firms to enter and exit the industry • No control over price. • No need to advertise
2
Review1. Why is a perfectly competitive firm a price taker?2. How do firms determine what output to produce?3. Draw and label a perfectly competitive firm
producing 10 units making a profit of $304. Draw and label a perfectly competitive firm
producing 10 units making a loss of $305. On your graph, identify the firms supply curve6. On your graph, identify the shut down point7. What happens in the industry if there is a profit?8. What happens in the industry if there is a loss?9. Draw a perfectly competitive firm in long run
equilibrium10. List 10 words that rhyme with the word “great” 3
P
Q
MCATC
8
D=MR
P
Q400
D
S
Industry Firm(price taker)
$10 $10
The Competitive Firm is a Price TakerPrice is set by the Industry
Loss
4
Is the firm making a profit or a loss? Why?
Perfect Competition
in the Long-Run
5
You are a wheat farmer. You learn that there is a more profit in making corn.
What do you do in the long run?
In the Long-run…•Firms will enter if there is profit•Firms will leave if there is loss•So, ALL firms break even, they make NO economic profit
(No Economic Profit=Normal Profit) •In long run equilibrium a perfectly competitive firm is EXTREMELY efficient.
6
P
Q
P
Q5000
D
S
Industry Firm(price taker)
$15 $15
Side-by-side graph for perfectly completive industry and firm in the LONG RUN
7
MR=D
ATC
MC
8
Is the firm making a profit or a loss? Why?
Price = MC = Minimum ATCFirm making a normal profit
Firm in Long-Run Equilibrium
8
P
Q
$15
8
MR=D
ATC
MC
8
There is no incentive to enter or leave the
industryTC = TR
82%
Going from Short-Runto Long-Run
12
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
14
MR=DATC
MC
8
S1
$10
Firms enter to earn profit so supply increases in the industry
Price decreases and quantity increases
6000
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
15
MR=DATC
MC
8
Price falls for the firm because they are price takers.
Price decreases and quantity decreases
S1
$10 $10 MR1=D1
56000
P
Q
P
Q5000
D
Industry Firm 16
ATC
MC
New Long Run Equilibrium at $10 PriceZero Economic Profit
S1
$10 $10 MR1=D1
56000
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
17
MR=D
ATCMC
8
1. Is this the short or the long run? Why?2. What will firms do in the long run?3. What happens to P and Q in the industry?4. What happens to P and Q in the firm?
4000
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
18
MR=D
MC
8
S1
$20
Firms leave to avoid losses so supply decreases in the industry
Price increases and quantity decreases
ATC
4000
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
19
MR=D
MC
8
S1
$20
Price increase for the firm because they are price takers.
Price increases and quantity increases
ATC
4000
MR1=D1
9
$20
P
Q
P
Q
D
Industry Firm 20
MC
S1
$20
New Long Run Equilibrium at $20 PriceZero Economic Profit
ATC
4000
MR1=D1
9
$20
Going from Long-Run to Long-Run
21
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
22
MR=D
MC
8
Currently in Long-Run Equilibrium If demand increases, what happens in the short-run
and how does it return to the long run?
ATC
MR1=D1
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
23
MR=D
MC
8
D1
$20
Demand Increases The price increases and quantity increases
Profit is made in the short-run
ATC
MR1=D1
9
$20
P
Q
P
Q5000
D
S
Industry Firm
$15 $15
24
MR=D
MC
8
D1
$20
Firms enter to earn profit so supply increases in the industry
Price Returns to $15
ATC
MR1=D1
9
$20
7000
S1
P
Q
P
Q
D
Industry Firm
$15 $15
25
MR=D
MC
8
D1
Back to Long-Run EquilibriumThe only thing that changed from long-run to
long-run is quantity in the industry
ATC
7000
S1
Efficiency
26
PURE COMPETITION AND EFFICIENCY
•Perfect Competition forces producers to use limited resources to their fullest.•Inefficient firms have higher costs and are the first to leave the industry.•Perfectly competitive industries are extremely efficient
In general, efficiency is the optimal use of societies scarce resources
1. Productive Efficiency2. Allocative Efficiency
There are two kinds of efficiency:
27
Efficiency RevisitedB
ikes
Computers
14
12
10
8
6
4
2
0
0 2 4 6 8 10
A
B
C
D
F
E
Which points are productively efficient?Which are allocatively efficient?
G
28
Productive Efficient combinations are A through D
(they are produced at the lowest cost)
Allocative Efficient combinations depend on
the wants of society
Productive Efficiency
Price = Minimum ATC
The production of a good in a least costly way. (Minimum amount of resources are being used)
Graphically it is where…
29
P
Q
MCATC
Quantity
Pri
ce
Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point).
Short-Run
Profit
30
D=MR
P
Q
MC
ATC
Quantity
Pri
ce
Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point).
Short-Run
Loss
31
D=MR
PD=MR
Q
MCATC
Quantity
Pri
ce
Notice that the product is being made at the lowest possible cost (Minimum ATC)
Long-Run Equilibrium
32
Allocative Efficiency
Price = MC
Producers are allocating resources to make the products most wanted by society.
Graphically it is where…
33
Why? Price represents the benefit people get from a product.
P MR
Q
MC
Quantity
Pri
ce
The marginal benefit to society (as measured by the price) equals
the marginal cost.
Long-Run Equilibrium
Optimal amount being produced
34
$5 MR
15
MC
Quantity
Pri
ce
The marginal benefit to society is greater the
marginal cost.Not enough produced.
Society wants more
What if the firm makes 15 units?
20 Underallocation of resources
$3
35
$5 MR
22
MC
Quantity
Pri
ce
The marginal benefit to society is less than the
marginal cost. Too much Produced.Society wants less
20 Overallocation of resources
$7
36
What if the firm makes 22 units?
PD=MR
Q
MCATC
Quantity
Pri
ce
P = Minimum ATC = MCEXTREMELY EFFICIENT!!!!
Long-Run Equilibrium
37
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