copyright © 2010 pearson education, inc. publishing as...

1 of 39Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.

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CHAPTER11

Firms in Perfectly Competitive Markets

Fernando Quijano

Prepared by:

The market for organically grown

food has expanded rapidly in the

United States.


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11.1 Perfectly Competitive Market Explain what a perfectly competitive market is and

why a perfect competitor faces a horizontal demand curve.

11.2 How a Firm Maximizes Profit in a PerfectlyCompetitive Market.Explain how a firm maximizes profit in a perfectly competitive market.

11.3 Illustrating Profit or Loss on the Cost Curve GraphUse graphs to show a firm’s profit or loss.

11.4 Deciding Whether to Produce or to Shut Down in the Short RunExplain why firms may shut down temporarily.

11.5 “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long RunExplain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run.

11.6 Perfect Competition and EfficiencyExplain how perfect competition leads to economic efficiency.

CHAPTER11Chapter Outline and

Learning ObjectivesFirms in Perfectly Competitive Markets


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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

• Growing Wheat• Apples

Many

Differentiated

High

• Clothing Stores• Restaurants

Few

Identical or differentiatedLow

• Manufacturingcomputers

• Manufacturingautomobiles

One

Unique

Entry blocked

• First-classmail delivery

• Tap water

Table 11-1The Four Market Structures


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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 Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.

11.1 LEARNING OBJECTIVE


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FIGURE 11-1A Perfectly Competitive Firm Faces a Horizontal Demand Curve

Perfectly Competitive Markets

The Demand Curve for the Output of a Perfectly Competitive Firm

A firm in a perfectly competitive market is selling exactly the same product as many other firms. Therefore, it can sell as much as it wants at the current market price, but it cannot sell anything at all if it raises the price by even 1 cent. As a result, the demand curve for a perfectly competitive firm’s output is a horizontal line. In the figure, whether the wheat farmer sells 6,000 bushels per year or 15,000 bushels has no effect on the market price of $4.

Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.



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

Perfectly Competitive Markets

The Demand Curve for the Output of a Perfectly Competitive Firm

In a perfectly competitive market, price is determined by the intersection of market demand and market supply.In panel (a), the demand and supply curves for wheat intersect at a price of $4 per bushel. An individual wheat farmer like Farmer Parker cannot affect the market price for wheat. Therefore, as panel (b) shows, the demand curve for Farmer Parker’s wheat is a horizontal line.

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

YOUR TURN: Test your understanding by doing related problem 1.6 at the end of this chapter.

Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.



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How a Firm Maximizes Profitin 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) The change in total revenue from selling one more unit of a product.

or ,quantityin Change

revenue in total Change Revenue MarginalQTRMRΔΔ

==

Explain how a firm maximizes profit in a perfectly competitive market.



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NUMBER OF BUSHELS

(Q)

MARKET PRICE(PER BUSHEL)

(P)

TOTAL REVENUE

(TR)

AVERAGE REVENUE

(AR)

MARGINAL REVENUE

(MR)

0123456789

10

$44444444444

$048

1216202428323640

-$4444444444

-$4444444444

Table 11-2Farmer Parker’s Revenue from Wheat Farming

Revenue for a Firm in a Perfectly Competitive Market




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QUANTITY(BUSHELS)

(Q)

TOTALREVENUE

(TR)

TOTALCOST(TC)

PROFIT(TR-TC)

MARGINAL REVENUE

(MR)

MARGINAL COST(MC)

0123456789

10

$0.004.008.00

12.0016.0020.0024.0028.0032.0036.0040.00

$2.005.007.008.50

10.5013.0016.5021.5028.5038.0050.50

-$2.00-1.001.003.505.507.007.506.503.50

-2.00-10.50

—$4.004.004.004.004.004.004.004.004.004.00

—$3.002.001.502.002.503.505.007.009.50

12.50

Determining the Profit-Maximizing Level of Output

Table 11-3Farmer Parker’s Profits from Wheat Farming




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How a Firm Maximizes Profitin a Perfectly Competitive MarketDetermining the Profit-Maximizing Level of Output

FIGURE 11-3The Profit-Maximizing Level of Output

In panel (a), Farmer Parker maximizes his profit where the vertical distance between total revenue and total cost is the largest.

Panel (b) shows that Farmer Parker’s marginal revenue (MR) is equal to a constant $4 per bushel. Farmer Parker maximizes profits by producing wheat up to the point where the marginal revenue of the last bushel produced is equal to its marginal cost, or MR = MC.




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How a Firm Maximizes Profitin a Perfectly Competitive MarketDetermining the Profit-Maximizing Level of Output

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 onthe Cost Curve Graph

Profit = (P x Q) − TC

−×Q

QP )(=

QProfit

QTC

P ATCQ

= −Profit

Profit = (P − ATC) x Q

or

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



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Showing a Profit on the Graph

FIGURE 11-4The Area of Maximum Profit

Illustrating Profit or Loss onthe Cost Curve Graph

A firm maximizes profit at the level of output at which marginal revenue equals marginal cost. The difference between price and average total cost equals profit per unit of output. Total profit equals profit per unit multiplied by the number of units produced. Total profit is represented by the area of the green-shaded rectangle, which has a height equal to (P - ATC) and a width equal to Q.




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

OUTPUT PER DAY

TOTAL COST

0 $10.00

1 20.50

2 24.50

3 28.50

4 34.00

5 43.00

6 55.50

7 72.00

8 93.00

9 119.00

YOUR TURN: For more practice, do related problems 3.3 and 3.4 at the end of this chapter.




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Illustrating Profit or Losson the Cost Curve GraphDon’t Let This Happen to YOU!Remember That Firms Maximize Their Total Profits, Not Their Profits 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 (itstotal cost equals its total revenue).

3. P < ATC, which means the firm experienceslosses.

Illustrating When a Firm Is Breaking Even or Operating at a Loss

Illustrating Profit or Losson the Cost Curve Graph




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FIGURE 11-5A Firm Breaking Even and a Firm Experiencing Losses

Illustrating When a Firm Is Breaking Even or Operating at a Loss

Illustrating Profit or Losson the Cost Curve Graph

In panel (b), price is below average total cost, and the firm experiences a loss. The loss is represented by the area of the red-shaded rectangle, which has a height equal to (ATC - P) and a width equal to Q.

In panel (a), price equals average total cost, and the firm breaks even because its total revenue will be equal to its total cost. In this situation, the firm makes zero economic profit.




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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 experiencing losses has two choices:

Explain why firms may shut down temporarily.



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When to Close a LaundryMaking

theConnection

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

YOUR TURN: Test your understanding by doing related problems 4.5 and 4.6 atthe end of this chapter.




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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 11-6The Firm’s Short-Run Supply Curve

Deciding Whether to Produce or to Shut Down in the Short RunThe Supply Curve of a Firm in the Short Run

For any given price, we can determine the quantity of output the firm will supply from the marginal cost curve. In other words, the marginal cost curve is the firm’s supply curve. The firm will shut down if the price falls below average variable cost. The marginal cost curve crosses the average variable cost at the firm’s shutdown point. This point occurs at output level QSD.For prices below PMIN, the supply curve is a vertical line along the price axis, which shows that the firm will supply zero output at those prices. The red line in the figure is the firm’s short-run supply curve.




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FIGURE 11-7Firm Supply and Market Supply

Deciding Whether to Produce or to Shut Down in the Short RunThe Market Supply Curve in a Perfectly Competitive Industry

We can derive the market supply curve by adding up the quantity that each firm in the market is willing to supply at each price. In panel (a), one wheat farmer is willing to supply 15,000 bushels of wheat at a price of $4 per bushel. If every wheat farmer supplies the same amount of wheat at this price and if there are 167,000 wheat farmers, the total amount of wheat supplied at a price of $4 will equal 15,000 bushels per farmer × 167,000 farmers = 2.5 billion bushels of wheat.




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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

EXPLICIT COSTS

WaterWagesOrganic fertilizerElectricityPayment on bank loan

$10,000$15,000$10,000

$5,000$45,000

IMPLICIT COSTSForegone salaryOpportunity cost of the $100,000 she has invested in her farm

$30,000$10,000

Total cost $125,000

Economic Profit and the Entry or Exit DecisionTable 11- 4Farmer Moreno’s Costs per Year

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

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



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Economic Profit Leads to Entry of New FirmsFIGURE 11-8The Effect of Entry on Economic Profits

Economic Profit and the Entry or Exit Decision





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FIGURE 11-9The Effect of Exit on Economic Losses

Economic Losses Lead to Exit of Firms




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The Effect of Exit on Economic LossesFIGURE 11-9The 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 11-10The 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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Easy Entry Makes the Long Run Pretty Short in the Apple iPhone Apps Store

Makingthe

Connection

Economic profits are rapidly competed away in the iPhone apps store.


In a competitive market, earning an economic profit in the long run is extremely difficult. And the ease of entering the market for iPhone apps has made the long run pretty short.




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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

Explain how perfect competition leads to economic efficiency.



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How Productive Efficiency Benefits ConsumersSolved Problem 11-6

YOUR TURN: For more practice, do related problems 6.4, 6.5, and 6.6 at the end of this chapter.

In the long run, firms only break even on their investment in producing high-technology goods.That result implies that investors in these firms are also unlikely to earn an economic profit in the long run.




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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

Figure 1The demand for a product increases after it is “green certified.” The graph assumes that the firm did not spend money to acquire certification for its product.

It Isn’t Easy—or Cheap—to Be Green>>

Figure 2The demand for a product increases after it is “green certified.” The marginal cost and average total cost curves shift up due to the cost of certification.


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Allocative efficiencyAverage revenue (AR)Economic lossEconomic profitLong-run competitive equilibriumLong-run supply curveMarginal revenue (MR)

Perfectly competitive marketPrice takerProductive efficiencyProfitShutdown pointSunk cost

KEY TERMS

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