Today

Perfect competition Profit-maximization in the SR The firm’s SR supply curve The industry’s SR supply curve

Perfect Competition

Chapter 21

Market Structure

Market Structure: the key features of a market, including:– # of firms– type of product– nature of firm’s cost– # of buyers

Market structure is usually defined in terms of sellers.

Perfect

Competition =

Manyfirms

Oligopoly = A

few firms

Four Basic Models

Monopoly = One

firm

Monopolistic

Competition =

Some firms

A Rule of Thumb

The fewer the firms in the market, the more control each firm has over price.

Perfect Competition

Perfect Competition:Five Assumptions Homogeneous Product: Goods

produced by different sellers are perceived to be identical by consumers.

Perfect Information about Prices Given the first two assumptions, will a

seller be able to sell his product for a price higher than his competitors?

Assumptions 3-5

The market is large enough to support many sellers.

The firms are price takers: they acts as if their own output has no effect on price.

No barriers to entry: firms can enter and exit the market freely.

Examples of Perfectly Competitive Industries wheat, corn, etc. steel coal

Revenue (assuming fixed price per unit) Total Revenue (TR) = price x quantity

sold (PQ) Average Revenue (AR) = (TR/Q) =

(PQ/Q) = P Marginal Revenue (MR) = TR/Q the

change in TR when output rises by one unit.

Profits = TR - TC (or TR - TFC - TVC)

Note on Marginal Revenue

The above definition is a general definition of MR that works for all industry structures. In perfect competition, since firms are price takers, MR = P = AR.

For any other market structure, MR < P.

Demand for a Particular Firm’s Output

q Q

D

SPP Typical Firm Industry or Market

The price-taking firm faces a perfectly elastic demand for its product at the market price.

Q*

P*P*d = AR = MR

Short-Run Production Decisions

Decision 1

Should the firm produce anything? Produce if: profit producing > profit not producing TR - TFC - TVC > 0 - 0 -TFC TR > TVC TR/Q > TVC/Q Produce in SR ifProduce in SR if P > AVCP > AVC

Graph of Decision 1

q

P Typical Firm

P1Produce

P2Don’t Produce

AV C

Decision 2

If the firm does produce in the SR, then: Decision 2: How much should it produce

in the SR? max profits = max (TR - TFC - TVC) Given TFC do not vary with output, we

can ignore them when choosing output. If we choose q to maximize TR- TVC, we will also be maximizing profits.

Total Revenue on Graph of Marginal Revenue

q

P

P = AR = MR

TR is the area under MR.

Total Variable Cost on Graph of Marginal Cost

q

P MC

TVC is the area under MC.

Total Revenue Minus Total Variable Cost on Graph

q

P MC

If we maximize TR - TVC then we will maximize profits. TR - TVC is maximized when MR = MC.

Profit over operating costs.

MR = P = AR

q*

The Firm’s Profit-Maximizing Rule Choose quantity where MR = MC (given

MC is sloping upward and AVC are covered).

Price-Taking and Profit-Maximization For price-taking firms, MR = P. Maximize profits by choosing q where

MC = P.

The Firm’s Supply Curve

The firm’s supply curve tells how much the firm will produce in the short run at every possible price, given a fixed plant size.

Graphing the Firm’s Supply Curve

q

P MC

P0

AVC

Graphing the Firm’s Supply Curve

q

P MC

P0

P1

AVC

Graphing the Firm’s Supply Curve

q

P MC

P0

P1

P2

AVC

Graphing the Firm’s Supply Curve

q

P MC

P0

P1

P2

P3AVC

Graphing the Firm’s Supply Curve

q

P

MC

P0

P1

P2

P3AVC

SRSSRS

Firm’s SR Supply Curve

The firm’s supply curve is equal to its MC curve above AVC.

P1 is sometimes called the “shutdown point” because if price falls below P1, the firm shuts down in the short run.

Industry Short Run Supply Curve

Industry SR Supply Curve: tells us how much the industry will produce at every possible price, given fixed plant sizes and a fixed number of firms.

Deriving Industry SupplyP P P

10 q Q

IndustryFirm 2Firm 1mc1

1522 25 32 4220

SRS

1

2

3 mc2

1715

The industry supply curve is the horizontal summation of the firms’ marginal cost curves (above their AVC curves).

Next Time

SR market equilibrium Changes in equilibrium LR equilibrium

Group Work

The firm’s SR supply curve. The Industry’s SR supply curve.

The Price-Taking Firm’s SR Supply Curve Look at the graph (next slide) to answer these

questions: In the short run, if the market price is $3, what

quantity will the firm produce? _____ In the short run, if the market price is $5.25,

what quantity will the firm produce? _____ In the short run, if the market price is $7.50,

what quantity will the firm produce? _____ Trace out the firm's short-run supply curve.

Firm’s SR Supply Curve

0

2

4

6

8

10

12

0 2 4 6 8 10 12 14 16 18 20 22 24

Quantity

$/q MC

ATC

AVC

Short Run Industry Supply

Suppose that there are 100 price-taking firms in this industry and all have identical cost curves to the firm depicted in the graph.

Draw the short-run industry supply curve in the right-hand panel of the next slide. Be sure to use the scale provided.

Short Run Industry Supply

0

2

4

6

8

10

12

0 2 4 6 8 10 12 0 200 400 600 800 1000

Quantity

$/q MC

ATC

AVC

Typical Firm Industry

Quantity