Unit 3:
Costs of Production and
Perfect Competition
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ACDC Leadership 2015
1
Perfect
Competition
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ACDC Leadership 2015
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Review
1. Identify the 4 Market Structures
2. Identify the characteristics of perfect competition
3. Why is a perfectly competitive firm a “price
taker”?
4. Explain why perfectly competitive firms make
little profit
5. How do ALL firms determine what output to
produce?
6. Draw a perfectly competitive firm producing 10
units at a price of $10 making a profit of $30
7. Draw and label a perfectly competitive firm
making a loss.
8. On your graph, identify the shut down point
9. List 10 words that rhyme with the word “great”
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ACDC Leadership 2015
3
Drawing side-by-side graph for perfectly
completive industry and firm
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
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ACDC Leadership 2015
Q
8
Q
Firm
(price taker)
4
Which of the following is a
correctly labeled graph for
firm making economic
profit?
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ACDC Leadership 2015
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P
ATC
MC
#1
P
MC
#3
ATC
MR=D
PF
MR=D
Q
P
#2
Q
QF
P
MC
#4
QF
ATC
ATC
MC
MR=D
MR=D
Q
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ACDC Leadership 2015
QF
Q
QF
P
MC
#1
ATC
P
MC
#3
ATC
MR=D
PF
MR=D
Q
Q
They
are all wrongQ
P #4
#2
ATC
MC
for different reasons
F
P
F
ATC
MC
MR=D
MR=D
Q
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ACDC Leadership 2015
QF
Q
Q
QF
P
ATC
MC
#1
P
MC
#3
ATC
MR=D
PF
MR=D
Profit
too big
ATC>P
Q
P
#2
QF
P
MC
MC
MR=D
MR=D
MC&ATC
Wrong
Q
Q
QF
#4
QF
ATC
ATC
MR > MC
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ACDC Leadership 2015
Q
QF
Where is the profit maximization point? How do you know?
What output should be produced? What is TR? What is TC?
How much is the profit or loss? Where is the Shutdown Point?
Cost and Revenue
$25
MC
20
Profit
15
MR=P
ATC
AVC
10
Total Revenue Total Cost
0
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ACDC Leadership 2015
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9
Perfect Competition
in the Long-Run
You are a wheat farmer. You learn that
there is a more profit in making corn.
What do you do in the long run?
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ACDC Leadership 2015
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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.
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ACDC Leadership 2015
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Side-by-side graph for perfectly completive
industry and firm in the LONG RUN
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
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ACDC Leadership 2015
Q
8
Q
Firm
(price taker)
12
Firm in Long-Run Equilibrium
Price = MC = Minimum ATC
Firm is making NO economic profit
Firm is making positive accounting profit
P
MC
ATC
$15
MR=D
TC = TR
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ACDC Leadership 2015
There is no incentive to
enter or leave the
industry
8
Q
13
Going from Short-Run
to Long-Run
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ACDC Leadership 2015
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1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000 6000 Q
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ACDC Leadership 2015
Industry
8
Firm
Q
15
Firms enter to earn profit so supply
increases in the industry
Price decreases and quantity increases
P
S
P
MC
S1
ATC
$15
MR=D
$15
$10
D
5000 6000 Q
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ACDC Leadership 2015
Industry
8
Firm
Q
16
Price falls for the firm because they are
price takers.
Price decreases and quantity decreases
P
S
P
MC
S1
ATC
$15
$15
MR=D
$10
$10
MR1=D1
D
5000 6000 Q
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ACDC Leadership 2015
Industry
5 8
Firm
Q
17
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
MR1=D1
$10
D
5000 6000 Q
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ACDC Leadership 2015
Industry
5
Firm
Q
18
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
$15
MC
ATC
MR=D
$15
D
4000 5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
19
Firms leave to avoid losses so supply
decreases in the industry
Price increases and quantity decreases
S1
P
S
P
MC
ATC
$20
$15
MR=D
$15
D
4000 5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
20
Price increase for the firm because they
are price takers.
Price increases and quantity increases
S1
P
S
P
$20
MC
$20
$15
$15
ATC
MR1=D1
MR=D
D
4000 5000
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ACDC Leadership 2015
Industry
Q
89
Firm
Q
21
New Long Run Equilibrium at $20 Price
Zero Economic Profit
S1
P
P
$20
MC
$20
ATC
MR1=D1
D
4000
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ACDC Leadership 2015
Industry
Q
9
Firm
Q
22
Going from Long-Run
to Long-Run
Constant Cost Industry- New firms
entering the market does not increase the
costs for the firms already in the market.
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ACDC Leadership 2015
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Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
24
Demand Increases
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000
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ACDC Leadership 2015
Industry
Q
8 9
Firm
Q
25
Firms enter to earn profit so supply
increases in the industry
Price Returns to $15
P
S S1
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000 7000 Q
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ACDC Leadership 2015
Industry
8 9
Firm
Q
26
Back to Long-Run Equilibrium
The only thing that changed from long-run to
long-run is quantity in the industry
S1
P
P
MC
ATC
$15
MR=D
$15
D1
D
7000 Q
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ACDC Leadership 2015
Industry
8
Firm
Q
27
What if demand falls?
If demand decreases, what happens in the shortrun and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
28
Demand Decreases
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
ATC
$15
$10
5000
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ACDC Leadership 2015
MR=D
$15
$10
D1 D
Q
Industry
MR1=D1
7 8
Firm
Q
29
Demand Decreases
The price increases and quantity increases
Profit is made in the short-run
S1
P
S
P
MC
ATC
$15
$10
MR=D
$15
$10
3000 5000
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ACDC Leadership 2015
D1 D
Q
Industry
MR1=D1
7 8
Firm
Q
30
Demand Decreases
The price increases and quantity increases
Profit is made in the short-run
S1
P
P
MC
ATC
$15
MR=D
$15
D1
3000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
31
Practice
32
2012 Multiple Choice #23
33
2012 Multiple Choice #38
34
2010 FRQ #1
36
37
Going from Long-Run
to Long-Run
Increasing Cost Industry- New firms
entering the market increase the costs for
the firms already in the market.
(Only asked once on a FRQ- 2011 Form B)
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ACDC Leadership 2015
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Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
Q
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ACDC Leadership 2015
Industry
Q
Firm
39
INCREASING COST Industry
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
$25
$25
ATC
$15
$15
MR=D
D1
D
Q
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ACDC Leadership 2015
Industry
Q
Firm
40
Firms enter to earn profit but fight for
resources causing costs to increase
Price Falls to $20
$25
$25
MC1
MC ATC1
ATC
$20
$15
$15
MR=D
P
S
P
S1
D1
D
Q
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ACDC Leadership 2015
Industry
Q
Firm
41
Firms enter to earn profit but fight for
resources causing costs to increase
Price Falls to $20
P
S1
MC1
P
ATC1
MR1
$20
D1
Q
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ACDC Leadership 2015
Industry
Q
Firm
42
2008 Audit Exam