Unit 5 Market Structures
Chapter 13 Perfect Competition
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples of Perfect Competition: Avocado farmers,
sunglass huts, and hammocks in Mexico
• Many small firms
• Identical products (perfect substitutes)
• Easy for firms to enter and exit the industry
• Seller has no need to advertise
• Firms are “Price Takers”
The seller has NO control over price.
2
I. Demand Curve for Perfect
Competition
a) Price is the same for all quantities
demanded.
1. If one firm charges above the market price, NO
one will buy.
2. There is no reason to price low because
consumers will buy just as much at the market
price.
b) Curve is perfectly elastic (horizontal line).
The Competitive Firm is a Price Taker
Price is set by the Industry
P
S
P
$15
Demand
$15
D
5000
Industry
Q
Q
Firm
(price taker)
4
II. The Competitive Firm is a Price Taker
Price is set by the Industry
A. What is the additional
revenue for selling an P
additional unit?
1. 1st unit earns $15
2. 2nd unit earns $15
3. Marginal revenue is $15
constant at $15
Demand
MR=D=AR=P
Q
Firm
(price taker)
5
III. Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
A. To maximum profit firms must make the right
output
B. Firms should continue to produce until the
additional revenue from each new output equals
the additional cost.
Example (Assume the price is $10)
1. Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11 6
Profit Maximizing
Rule
MR = MC
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
P
$9
MC
8
7
6
5
4
3
2
1
MR=D=AR=P
Profit = $18
ATC
AVC
Don’t forget
that averages
show PER
UNIT COSTS
Total Cost=$45
Total Revenue =$63
1 2 3 4 5 6 7 8 9 10
Q
8
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
Cost and Revenue
MC
$9
8
7
6
5
4
3
2
1
ATC
Loss =$7
AVC
MR=D=AR=P
Total Cost = $42
Total Revenue=$35
1 2 3 4 5 6 7 8 9 10
Q
9
Shut Down Rule
A. A firm should continue to produce as
long as the price is above the AVC
B. When the price falls below AVC then the
firm should minimize its losses by shutting
down
C. Why? If the price is below AVC the firm is
losing more money by producing than they
would have to pay to shut down.
10
SHUT DOWN! Produce Zero
Cost and Revenue
MC
$9
8
7
6
5
4
3
2
1
ATC
AVC
1 2 3 4 5 6 7 8 9 10
Minimum AVC
is shut down
point
Q
11
P<AVC. They should shut down
Producing nothing is cheaper than staying open.
Cost and Revenue
MC
$9
8
7
6
5
4
3
2
1
ATC
Fixed Costs=$10
AVC
TC=$35
MR=D=AR=P
TR=$20
1 2 3 4 5 6 7 8 9 10
Q
12
#1
Should the firm produce? Yes
What output should the firm produce? 10
What is TR at that output? What is TC?
How much profit or loss? Profit=$40
TR=$140
TC=$100
$20
Cost and Revenue
MC
15
14
MR=D=AR= P
ATC
10
AVC
6
5
0
6 7
10
Q
13
#2
What output should the firm produce? Zero Shutdown
(Price below AVC)
What is TR at MR=MC point?$45
What is TC at MR=MC point?$55
How much profit or loss? Loss=Only Fixed Cost $5
$20
MC
ATC
Cost and Revenue
15
AVC
11
10
9
MR=D=AR=P
5
0
5 7
Q
14
What output should the firm produce? 6
What is TR at that output? $90
What is TC? $120
How much profit or loss? Loss= $30
#3
$40
MC
Cost and Revenue
30
ATC
20
19
15
10
0
AVC
MR=D=AR=P
6 8
Q
15
IV. Perfect Competition in the Long
Run
a) Firms will enter industry if there’s a profit.
b) Firms will leave if there is loss.
c) ALL firms break even , they make NO
economic profit
d) In long run equilibrium a perfectly
competitive firm is EXTREMELY efficient.
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
Q
8
Q
Firm
(price taker)
17
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
Industry
Q
8
Firm
Q
18
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
Industry
Q
8
Firm
Q
19
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
Industry
Q
5
8
Firm
Q
20
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
MR1=D1
$10
D
5000
6000
Industry
Q
5
Firm
Q
21
V. Perfect Competition and Efficiency
a) Efficiency: optimal use of societies scarce
resources.
b) Producers must use limited resources to their
fullest.
c) Inefficient firms have higher costs and are
forced to leave the industry.