the model of perfect competition
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The Model of Perfect Competition. Microeconomics - Dr. D. Foster. Perfect Competition - An Ideal. Firms are primarily distinguished from each other by the degree of competition they face:. Perfect Competition. Monopolistic Competition. Monopoly. Oligopoly. Profit maximization. - PowerPoint PPT PresentationTRANSCRIPT
The Model of Perfect Competition
Microeconomics - Dr. D. Foster
Perfect Competition - An Ideal
Firms are primarily distinguished from each other by the degree of competition they face:
Profit maximization.
The Model of Perfect Competition.
Allocative and Productive efficiencies.
Long-run costs and adjustments
Perfect Competitio
n
MonopolyMonopolistic
Competition
Oligopoly
Profit Maximizing RuleProfit Maximizing Rule
No matter what kind of firm we are talking about, they will max. profit when:
Marginal Revenue = Marginal CostMarginal Revenue = Marginal Cost (MR) (MC) (MR) (MC)
If MR > MC, you are foregoing profit.If MR < MC, you are foregoing profit.
Perfect CompetitionPerfect Competition
All goods are identicalidentical.--One cannot be (usefully) distinguished from another.
ManyMany buyers and sellers.--No one can affect price through their actions.
There are no barriersno barriers to entry/exit.--Firms cannot earn economic profit in the long run.
Buyers & sellers have perfect informationinformation.--A single price will prevail in the market.
Perfect CompetitionPerfect Competition
Market priceprice = price to the firm = MRMR(This is the “demand” for the firm’s output & is perfectly elastic.)(This is the “demand” for the firm’s output & is perfectly elastic.)
MC
q*Q
Qe
Pe
PS
D
$
Pe = MR = d
q
A FirmThe Marketq1 q2
Perfect CompetitionPerfect Competition
How can we tell if a firm makes a profit?
Calculate: Total Revenue = P•q*& Total Cost = ATC •q*
Econ Profit = TR - TC
$
MR = d
q
A Firm
Pe
MC
q*
ATC
Scenario #1 - Positive Scenario #1 - Positive ProfitProfit
The ATC must be less than the price, so that calculated profit is positive.
$
MR = d
q
A Firm
Pe
MC
q*
ATCWhat will
happen in this industry in the
long run?
Scenario #2 - Zero Econ Scenario #2 - Zero Econ ProfitProfit
The ATC must be equal to the price, so that calculated profit is zero.
A Firm
$
MR = d
q
Pe
MC
q*
ATCWhat will
happen in this industry in the
long run?
Scenario #3 - Negative Scenario #3 - Negative Profit IProfit I
The ATC must be more than the price, so that calculated profit is negative.
What will happen in this industry in the
long run?
$
MR = d
q
A Firm
Pe
MC
q*
ATCAVC
Will this firm stay in business in the
short run?It depends . . .
Scenario #3 - Negative Scenario #3 - Negative Profit II:Profit II:
The Shutdown PointThe Shutdown PointThe firm will shut down, right away, if the
Price (MR) is less than the AVC…or, if the total loss > fixed costs
What will happen in this industry in the
long run?
$
MR = d
q
A Firm
Pe
MC
q*
ATC
AVC
Fixed Costs
Do worksheet Do worksheet on perfect on perfect
competition.competition.
Perfect CompetitionPerfect Competition & Efficiency & Efficiency
Allocative EfficiencyAllocative Efficiency (What to produce?)
Productive EfficiencyProductive Efficiency (How to produce?)
occurs when Price = Marginal Cost
Why ?Why ?
occurs where output level is at the minimum ATC
Why ?Why ?
Perfect CompetitionPerfect Competition & Efficiency & Efficiency
Perfectly competitive firms are always Allocatively EfficientAllocatively Efficient
Perfectly competitive firms always charge a
price = MC. Why?
$
MR = d
q
Pe
MC
q*
ATC
In the LR, perfectly competitive firms produce
at min. ATC. Why?
In the LR, perfectly competitive firms are Productively EfficientProductively Efficient
Perfect Competition in Perfect Competition in LRLR
We know that in SR, firms can earn a positive, or negative, economic profit. What happens in the long run?
QQe
Pe
PS
D
The Market
QQe
Pe
PS
D
The Market
If econ profits are positive, entry occurs
S*
If econ profits are negative, exit occurs
S*
Perfect Competition in Perfect Competition in LRLR
If a firm earns positive economic profit, in the long run that will be dissipated as firms enter.
QQe
Pe
PS
D
The Market
$
MR = d
q
A Firm
Pe
MC
q*
ATCS*
MR* = d*Pe*
q*
In the LR, this firm earns 0
econ profit.
Perfect Competition in Perfect Competition in LRLR
If a firm earns negative economic profit, in the long run that will be eliminated as firms exit.
QQe
Pe
PS
D
The Market
$
MR = d
q
A Firm
Pe
MC
q
ATC
In the LR, this firm earns 0
econ profit.q*
MR* = d*Pe*
S*
Perfect Competition in Perfect Competition in LRLR
If the market is in equilibrium . . . econ profits = 0.If demand increases (e.g., incomes rise), what happens in SR and LR in this market?
D*
S3
QQe
Pe
PS
D
The Market
S1S2
D*
QQe
Pe
PS
D
The Market
LRSLRS11
LRSLRS22
LRSLRS33
The Paradox of Taxing The Paradox of Taxing Economic ProfitEconomic Profit
In the short run, there are no consequencesno consequences!
MC
Qe
Pe
PS $
Pe = MR = d
q
A FirmThe Market
D
D*
ATC
q*
MR* = d*P*
Q*
The Paradox of Taxing The Paradox of Taxing Economic ProfitEconomic Profit
In the short run, there are no consequencesno consequences!
But, what about the long runlong run?
Firms no longer earn an economic profit.
No firms will enter into this market.
The price will not fall; the output will not rise.
Long Run CostsLong Run Costs
$
q
A Firm
ATC1 ATC2
ATC3
LRAC
q*
Economies of scale
Diseconomies of scale
Long Run CostsLong Run CostsSpecial Case - The Flat Bottomed Special Case - The Flat Bottomed
LRACLRAC
$
q
A Firm
LRAC
q1
Constant Returns to scale
q2Firms of varying
size survive together; q1 is the “minimum
efficient scale.”
The Model of Perfect Competition
Microeconomics - Dr. D. Foster