perfect competition in the market for organic apples

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.

Fernando & Yvonn Quijano

Prepared by:

Chapter

11

Firms in Perfectly Competitive Markets

© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 48

Perfect Competition in the Market for Organic Apples

11.1 Define a perfectly competitive market and explain why a perfect competitor faces a horizontal demand curve.

11.2 Explain how a firm maximizes profits in a perfectly competitive market.

11.3 Use graphs to show a firm’s profit or loss.

11.4 Explain why firms may shut down temporarily.

11.5 Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run.

11.6 Explain how perfect competition leads to economic efficiency.

Learning Objectives

The process of competition is at the heart of the market system and is the focus of this chapter.

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Firms in Perfectly Competitive Markets

MARKET STRUCTURE

CHARACTERISTICPERFECT COMPETITION

MONOPOLISTIC COMPETITION OLIGOPOLY MONOPOLY

Number of firms

Type of product

Ease of entry

Examples of industries

Many

Identical

High

• Wheat• Apples

Many

Differentiated

High

• Selling DVDs• Restaurants

Few

Identical or differentiated

Low

• Manufacturing computers• Manufacturing automobiles

One

Unique

Entry blocked

• First-class mail delivery• Tap water

Table 11-1

The Four Market Structures

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Learning Objective 11.1

Perfectly competitive market A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market.

Price taker A buyer or seller that is unable to affect the market price.

A Perfectly Competitive Firm Cannot Affect the Market Price

Perfectly Competitive Markets

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FIGURE 11-1

A Perfectly Competitive Firm Faces a Horizontal Demand Curve

Perfectly Competitive MarketsThe Demand Curve for the Outputof a Perfectly Competitive Firm

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FIGURE 11-2The Market Demand for Wheat versus the Demand for One Farmer’s Wheat

Don’t Let This Happen to YOU!Don’t Confuse the Demand Curve for Farmer Parker’s Wheat with the Market Demand Curve for Wheat

Perfectly Competitive MarketsThe Demand Curve for the Outputof a Perfectly Competitive Firm

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How a Firm Maximizes Profit in a Perfectly Competitive Market


Profit Total revenue minus total cost.

Profit = TR – TC

Revenue for a Firm in a Perfectly Competitive Market

Average revenue (AR) Total revenue divided by the quantity of the product sold.

Marginal revenue (MR) Change in total revenue from selling one more unit of a product.

or ,quantityin Change

revenue in total Change Revenue Marginal

Q

TRMR

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Table 11-2

Farmer Parker’s Revenue from Wheat Farming

NUMBER OF BUSHELS

(Q)

MARKET PRICE(PER BUSHEL)

(P)

TOTAL REVENUE

(TR)

AVERAGE REVENUE

(AR)

MARGINAL REVENUE

(MR)

0

1

2

3

4

5

6

7

8

9

10

$4

4

4

4

4

4

4

4

4

4

4

$0

4

8

12

16

20

24

28

32

36

40

-

$4

4

4

4

4

4

4

4

4

4

-

$4

4

4

4

4

4

4

4

4

4

Revenue for a Firm in a Perfectly Competitive Market

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Determining the Profit-Maximizing Level of Output

Table 11-3

Farmer Parker’s Profits from Wheat Farming

QUANTITY(BUSHELS)

(Q)

TOTALREVENUE

(TR)

TOTALCOSTS

(TC)

PROFIT

(TR-TC)

MARGINAL REVENUE

(MR)

MARGINAL COST

(MC)

0

1

2

3

4

5

6

7

8

9

10

$0.00

4.00

8.00

12.00

16.00

20.00

24.00

28.00

32.00

36.00

40.00

$1.00

4.00

6.00

7.50

9.50

12.00

15.00

19.50

25.50

32.50

40.50

–$1.00

0.00

2.00

4.50

6.50

8.00

9.00

8.50

6.50

3.50

–0.50

— $4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

—

$3.00

2.00

1.50

2.00

2.50

3.00

4.50

6.00

7.00

8.00

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FIGURE 11-3

The Profit-Maximizing Level of Output

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1 The profit-maximizing level of output is where the difference between total revenue and total cost is the greatest.

2 The profit-maximizing level of output is also where marginal revenue equals marginal cost, or MR = MC.

From the information in Table 11-3 and Figure 11-3, we can draw the following conclusions:

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Illustrating Profit or Loss on the Cost Curve Graph


Profit = (P x Q) TC

Q

QP )(

Q

ProfitQ

TC

P ATCQ

Profit

Profit = (P ATC)Q

or

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Showing a Profit on the Graph

FIGURE 11-4

The Area of Maximum Profit


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Solved Problem 11-3Determining Profit-Maximizing Price and Quantity


OUTPUT PER DAY

TOTAL COST

MARGINAL COST

0 $10.00 ―

1 15.00 $5.00

2 17.50 2.50

3 22.50 5.00

4 30.00 7.50

5 40.00 10.00

6 52.50 12.50

7 67.50 15.00

8 85.00 17.50

9 105.00 20.00

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Don’t Let This Happen to YOU!Remember That Firms Maximize Total Profit, Not Profit per Unit

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1 P > ATC, which means the firm makes a profit.

2 P = ATC, which means the firm breaks even (its total cost equals its total revenue).

3 P < ATC, which means the firm experiences losses.

Illustrating When a Firm Is Breaking Evenor Operating at a Loss


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FIGURE 11-5

A Firm Breaking Even and a Firm Experiencing Losses

Illustrating When a Firm Is Breaking Evenor Operating at a Loss


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Losing Money in the Medical Screening Industry

Makingthe

Connection

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Deciding Whether to Produceor to Shut Down in the Short Run


1 Continue to produce

2 Stop production by shutting down temporarily

Sunk cost A cost that has already been paid and that cannot be recovered.

In the short run, a firm suffering losses has two choices:

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When to Close a LaundryMaking

the

Connection

Keeping a business open even when suffering losses can sometimes be the best decision for an entrepreneur in the short run.

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Deciding Whether to Produce or to Shut Down in the Short Run


Shutdown point The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.

The Supply Curve of a Firm in the Short Run

Total revenue < Variable cost,

P × Q < VC

P < AVC

or, in symbols:

If we divide both sides by Q, we have the result that the firm will shut down if:

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FIGURE 11-6

The Firm’s Short-Run Supply Curve


The Supply Curve of a Firm in the Short Run

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FIGURE 11-7

Firm Supply and Market Supply


The Market Supply Curve in a Perfectly Competitive Industry

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“If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run


Economic Profit and the Entry or Exit Decision

Table 11- 4

Farmer Moreno’s Costs per Year

EXPLICIT COSTS

Water

Wages

Organic fertilizer

Electricity

Payment on bank loan

$10,000

$15,000

$10,000

$5,000

$45,000

IMPLICIT COSTS

Foregone salary

Opportunity cost of the $100,000 she has invested in her farm

Total Cost

$30,000

$10,000

$125,000

Economic profit A firm’s revenues minus all its costs, implicit and explicit.

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Economic Profit Leads to Entry of New Firms

FIGURE 11-8

The Effect of Entry on Economic Profits



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FIGURE 11-9

The Effect of Exit on Economic Losses

Economic Losses Lead to Exit of Firms



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FIGURE 11-9

The Effect of Exit on Economic Losses (continued)




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Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs.

Long-Run Equilibrium in a Perfectly Competitive Market

Long-run competitive equilibrium The situation in which the entry and exit of firms has resulted in the typical firm breaking even.




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FIGURE 11-10

The Long-Run Supply Curve in a Perfectly Competitive Industry


The Long-Run Supply Curve in a Perfectly Competitive Market

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Long-run supply curve A curve that shows the relationship in the long run between market price and the quantity supplied.

Increasing-Cost and Decreasing-Cost Industries

Industries with upward-sloping long run supply curves are called increasing-cost industries.

Industries with downward-sloping long-run supply curves are called decreasing-cost industries.


The Long-Run Supply Curve in a Perfectly Competitive Market

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The Decline of Apple Production in New York State

Makingthe

Connection

When apple growers in New York State stopped breaking even, many sold their land to housing developers.

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Perfect Competition and Efficiency


Productive efficiency The situation in which a good or service is produced at the lowest possible cost.

Productive Efficiency

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Solved Problem 11-6How Productive Efficiency Benefits Consumers


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1 The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold.

2 Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit.

3 Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

Allocative Efficiency

Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them.

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Allocative efficiency A state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

Allocative Efficiency

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An Inside LOOK Why Are Organic Farmers Worried about Wal-Mart?

Wal-Mart’s Organic Offensive

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Allocative efficiency

Average revenue (AR)

Economic loss

Economic profit

Long-run competitive equilibrium

Long-run supply curve

Marginal revenue (MR)

K e y T e r m s

Perfectly competitive market

Price taker

Productive efficiency

Profit

Shutdown point

Sunk cost

perfect competition in the market for organic apples

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