SLIDES CREATED BY ERIC CHIANG RADIUS IMAGESALAMY 8

SLIDES CREATED BY ERIC CHIANG RADIUS IMAGES/ALAMY 8 Perfect Competition CHAPTER 8 SLIDE 1

CHAPTER OBJECTIVES Name the primary market structures and describe their characteristics. Define a perfectly competitive market and the assumptions that underlie it. Determine a competitive firm’s profit maximizing quantity and price. Analyze the conditions for profit maximization, loss minimization, and plant shutdown for a firm. � CHAPTER 8 SLIDE 2

CHAPTER OBJECTIVES Derive the firm’s short-run supply curve. Use the short-run competitive model to determine market entry and exit in achieving long-run equilibrium. Describe why competition is in the public interest. CHAPTER 8 SLIDE 3

MARKET STRUCTURE ANALYSIS By observing a few industry characteristics, we can predict pricing and output behavior. Market structure depends on: number of firms. nature of product. barriers to entry. control over price. CHAPTER 8 SLIDE 4

PRIMARY MARKET STRUCTURES PERFECT COMPETITION MONOPOLISTIC COMPETITION OLIGOPOLY MONOPOLY CHAPTER 8 SLIDE 5

CHAPTER 8 SLIDE 6 AGSTOCK IMAGES, INC. /ALAMY THE CORN AND WHEAT INDUSTRIES ARE EXAMPLES OF PERFECT COMPETITION.

PERFECT COMPETITION Characteristics of perfect competition include: many buyers and sellers. homogeneous (standardized) products. no barriers to market entry or exit. no long-run economic profit. no control over price. CHAPTER 8 SLIDE 7

EASTPHOTO/AGE FOTOSTOCK THE RESTAURANT INDUSTRY IS AN EXAMPLE OF MONOPOLISTIC COMPETITION CHAPTER 8 SLIDE 8

MONOPOLISTIC COMPETITION Characteristics of monopolistic competition include: many buyers and sellers. differentiated products. little to no barriers to market entry or exit. no long-run economic profit. some control over price. CHAPTER 8 SLIDE 9

CHRISTOPHER HONEYWELL/ALAMY THE AUTOMOBILE INDUSTRY IS AN OLIGOPOLY CHAPTER 8 SLIDE 10

OLIGOPOLY Characteristics of oligopoly include: relatively few firms. interdependent decision making. substantial barriers to market entry. potential long-run economic profit. shared market power. considerable control over price. CHAPTER 8 SLIDE 11

CHRIS CHAMBERS/GETTY IMAGES THE NATIONAL FOOTBALL LEAGUE IS A MONOPOLY CHAPTER 8 SLIDE 12

MONOPOLY Characteristics of monopoly include: one firm. no close substitutes for product. nearly insuperable barriers to entry. potential long-run economic profit. substantial market power and control over price. CHAPTER 8 SLIDE 13

PERFECTLY COMPETITIVE MARKETS In a perfectly competitive market, each firm is a price taker: Individual firms get their prices from the market because they are so small that they cannot influence the market price. They take the price as given. CHAPTER 8 SLIDE 14

MARGINAL REVENUE THE CHANGE IN TOTAL REVENUE THAT RESULTS FROM THE SALE OF ONE ADDITIONAL UNIT OF A PRODUCT. TOTAL REVENUE = P × Q MARGINAL REVENUE = ΔTR / ΔQ CHAPTER 8 SLIDE 15

S 200 VS. FIRM DEMAND CURVE PRICE ($) MARKET DEMAND CURVE D = MR 200 D Qe INDUSTRY OUTPUT q 1 q 2 TYPICAL FIRM’S OUTPUT CHAPTER 8 SLIDE 16

THE PROFIT MAXIMIZATION RULE A FIRM MAXIMIZES PROFIT BY PRODUCING AT THE POINT WHERE MARGINAL REVENUE EQUALS MARGINAL COST (MR = MC). WE FIRST FOCUS ON SHORT-RUN (FIXED PLANT SIZE) PROFIT MAXIMIZATION. CHAPTER 8 SLIDE 17

120 SHORT-RUN PROFIT MAXIMIZATION MC 100 COST 80 D = MR 60 40 20 83 84 OUTPUT 85 Marginal cost of the 83 rd unit is less than MR (relinquishing the normal return from the 84 th unit). CHAPTER 8 SLIDE 18

COMPETITIVE FIRM EARNING PROFITS 120 MC 100 ATC COST 80 60 D = MR PROFITS AVC 40 Profit = (P − ATC) × Q 20 83 84 85 OUTPUT CHAPTER 8 SLIDE 19

FIVE STEPS TO MAXIMIZING PROFIT Step 1: Find MR = MC 120 MC 100 ATC COST 80 60 3 Step 2: Find optimal Q D = MR 1 5 PROFITS AVC 4 40 Step 3: Find optimal P Step 4: Find ATC 20 2 83 84 OUTPUT 85 Step 5: Find profit CHAPTER 8 SLIDE 20

SHORT RUN VS. LONG RUN SHORT RUN LONG RUN AT LEAST ONE FACTOR OF PRODUCTION (SUCH AS PLANT SIZE) IS FIXED. ALL FACTORS ARE VARIABLE. FIRMS ENTER IN RESPONSE TO PROFITS AND EXIT IN RESPONSE TO LOSSES. CHAPTER 8 SLIDE 21

NORMAL PROFITS 1, 200 1, 000 MC ATC COST 800 AVC D = MR 600 Normal profits are equal to zero economic profit where P = ATC. 400 200 1 2 3 4 5 6 OUTPUT CHAPTER 8 SLIDE 22

ZERO ECONOMIC PROFIT IN THE LONG RUN A perfectly competitive firm earns zero economic profit in the long run. Remember: zero economic profit (a normal profit) can still be a substantial accounting profit. CHAPTER 8 SLIDE 23

© RICK BARRENTINE/CORBIS LOSS MINIMIZATION: WHEN PRICE < ATC, FIRMS MINIMIZE LOSSES BY PRODUCING IF P > AVC OR SHUT DOWN IF P < AVC. CHAPTER 8 SLIDE 24

COMPETITIVE FIRM WITH LOSSES MC ATC COST AVC $80 70 LOSSES D = MR Negative profit = (P − ATC) × quantity = (70 − 80) × 35 = −$350 35 OUTPUT CHAPTER 8 SLIDE 25

SHUTDOWN POINTS ATC MC COST AVC $80 70 LOSSES D = MR 65 SHUTDOWN POINT 30 When price falls below $65 (minimum point on AVC), losses exceed fixed costs. OUTPUT CHAPTER 8 SLIDE 26

SHORT-RUN SUPPLY CURVE MC ATC COST AVC OUTPUT A firm’s short-run supply curve is its marginal cost curve above the minimum point on the average variable cost curve. CHAPTER 8 SLIDE 27

HERBERT SIMON (1916– 2001) Argued that firms are not always perfectly rational because they do not have perfect information and do not always strive to maximize profits. Won the Nobel Prize in Economics in 1978. CHAPTER 8 SLIDE 28

LONG-RUN ADJUSTMENTS If firms earn short-run economic profits, new firms enter the industry and existing firms expand their operations. If firms take losses, some firms leave the industry. Long-run equilibrium occurs where P = MR = MC = LRATCmin. CHAPTER 8 SLIDE 29

ECONOMIC PROFITS ATTRACT ENTRY FIRM S 0 S 1 PRICE ($) INDUSTRY 20 20 15 15 MC ATC D 0 = MR 0 PROFITS D 1 = MR 1 D Q 0 Q 1 INDUSTRY OUTPUT q 1 q 0 TYPICAL FIRM’S OUTPUT CHAPTER 8 SLIDE 30

ECONOMIC LOSSES LEAD TO EXIT FIRM PRICE ($) S 1 S 0 25 20 PRICE ($) INDUSTRY 25 20 MC ATC D 1 = MR 1 D 0 = MR 0 LOSSES D Q 1 Q 0 INDUSTRY OUTPUT q 0 q 1 TYPICAL FIRM’S OUTPUT CHAPTER 8 SLIDE 31

The long-run outcome in competitive markets exhibit: PRODUCTIVE EFFICIENCY: GOODS ARE SUPPLIED AT THE LOWEST POSSIBLE COST. ALLOCATIVE EFFICIENCY: MIX OF GOODS AND SERVICES IS JUST WHAT SOCIETY DESIRES. CHAPTER 8 SLIDE 32

LONG-RUN INDUSTRY SUPPLY Depends on long-run average total cost (LRATC), which varies according to economies or diseconomies of scale. When an industry expands, how do resource prices change? CHAPTER 8 SLIDE 33

PJRSTUDIO/ALAMY INCREASING-COST INDUSTRY: AS INDUSTRY EXPANDS, DEMAND FOR RAW MATERIALS (SUCH AS PRECIOUS METALS) INCREASES CHAPTER 8 SLIDE 34

© CHARLES PERTWEE/CORBIS DECREASING-COST INDUSTRY: AS INDUSTRY EXPANDS, ECONOMIES OF SCALE RESULT IN LOWER PRICES (e. g. , CHAPTER 8 SLIDE 35

CHAPTER 8 SLIDE 36 ERIC CHIANG CONSTANT-COST INDUSTRY: EXPANDS IN THE LONG RUN WITHOUT SIGNIFICANT CHANGES IN COST (e. g. , FAST FOOD RESTAURANTS)

LONG-RUN COMPETITIVE EQUILIBRIUM INDUSTRY FIRM MC PRICE AND COST PRICE S 0 PLR LRATC SRATC PLR D 0 = MR D QLR INDUSTRY OUTPUT q. LR TYPICAL FIRM’S OUTPUT P = MR = MC = SRATCmin= LRATCmin CHAPTER 8 SLIDE 37

INCREASING-, CONSTANT-, OR DECREASING-COST INDUSTRY CONSTANT COSTS S 0 S 1 c b SLR a D 1 PRICE b a S 0 S 1 c D 0 SLR S 1 b a c D 1 D 0 OUTPUT DECREASING COSTS PRICE INCREASING COSTS OUTPUT D 1 OUTPUT CHAPTER 8 SLIDE 38 SLR

KEY CONCEPTS • • • Market structure analysis Perfect competition Price taker Marginal revenue Profit-maximization rule Normal profits Shutdown point Short-run supply curve Increasing cost industry Decreasing cost industry Constant cost industry CHAPTER 8 SLIDE 39

WHICH OF THE FOLLOWING IS LIKELY TO BE THE MOST COMPETITIVE? A CABLE TELEVISION B AUTOMOBILES AND TRUCKS C OIL REFINING D INTERNATIONAL AIR TRAVEL E FARM COMMODITIES CHAPTER 8 SLIDE 40

CHAPTER 8 SLIDE 41 EPA EUROPEAN PRESSPHOTO AGENCY CREATIVE PRACTICE QUESTION IF THE MARGINAL REVENUE OF TEA IS $10 AND MARGINAL COST IS $5, WHY WOULDN’T THIS BE AN OPTIMAL LEVEL OF PRODUCTION?

IF GNOMES-R-US (A COMPETITIVE FIRM) PRODUCES AT THE POINT WHERE MARGINAL COST INTERSECTS THE AVERAGE TOTAL COST CURVE AT ITS MINIMUM POINT, THE FIRM WILL EARN: A ECONOMIC PROFITS. B NORMAL PROFITS. C A SHORT-RUN LOSS. D NO PROFITS AT ALL. CHAPTER 8 SLIDE 42

AP PHOTO/JEFF BARNARD, FILE PRACTICE QUESTION AS MORE STATES LEGALIZE MARIJUANA PRODUCTION, WHAT WILL HAPPEN TO THE MARKET PRICE? CHAPTER 8 SLIDE 43

SHOULD A COMPETITIVE FIRM KEEP PRODUCING EVEN IF IT FACES SHORT-RUN LOSSES? A YES, BECAUSE IT IS EARNING NORMAL PROFITS. B YES, AS LONG AS IT IS COVERING ITS VARIABLE COST. C NO, A FIRM SHOULD NEVER INCUR LOSSES. D NO, BECAUSE IT IS NOT COVERING ITS FIXED COST. CHAPTER 8 SLIDE 44

END OF CHAPTER SLIDES CREATED BY ERIC CHIANG 8 Tshooter/Shutterstock; Anton Balazh/Shutterstock CHAPTER 8 SLIDE 45