Kinh tế học vĩ mô - Chapter 11: Perfect competition

Perfect CompetitionChapter 11Laugher CurveQ. How many economists does it take to screw in a light bulb?A. Eight. One to screw it in and seven to hold everything else constant. Perfect CompetitionThe concept of competition is used in two ways in economics.Competition as a process is a rivalry among firms.Competition as a market structure.Competition as a ProcessCompetition involves one firm trying to take away market share from another firm.As a process, competition pervades the economy.A Perfectly Competitive MarketA perfectly competitive market is one which has highly restrictive assumptions, but which provides us with a reference point we can use in comparing different markets.A Perfectly Competitive MarketIn a perfectly competitive market:The number of firms is large.The firms' products are identical.There is free entry and exit, that is, there are no barriers to entry.There is complete information.Firms are profit maximizers.Both buyers and sellers are price takers.The Necessary Conditions for Perfect CompetitionThe number of firms is large.Large number of firms means that any one firm's output is very small when compared with the total market.What one firm does has no bearing on market quantity or market price.The Necessary Conditions for Perfect CompetitionFirms' products are identical.This requirement means that each firm's output is indistinguishable from any other firm’s output.Firms sell homogeneous product.The Necessary Conditions for Perfect CompetitionThere is free entry and free exit.Firms are free to enter a market in response to market signals such as price and profit.Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market.The Necessary Conditions for Perfect CompetitionThere is free entry and free exit.Technology may prevent some firms from entering the market.There must also be free exit, without incurring a loss.The Necessary Conditions for Perfect CompetitionThere is complete information.Firms and consumers know all there is to know about the market – prices, products, and available technology.Any technological advancement would be instantly known to all in the market.The Necessary Conditions for Perfect CompetitionFirms are profit maximizers.The goal of all firms in a perfectly competitive market is profit and only profit.There is no non-price competition (based on quality, brand name, or the like).The Necessary Conditions for Perfect CompetitionBoth buyers and sellers are price takers.A price taker is a firm or individual who takes the market price as given.Neither supplier nor buyer possesses market power. The Definition of Supply and Perfect CompetitionSupply is a schedule of quantities of goods that will be offered to the market at various prices.The Definition of Supply and Perfect CompetitionThis definition of supply requires the supplier to be a price taker.The Definition of Supply and Perfect CompetitionBecause of the definition of supply, if any of the conditions required for perfect competition are not met, the formal definition of supply disappears.The Definition of Supply and Perfect CompetitionThat the number of suppliers be large means that they do not have the ability to collude (act together with other firms to control price or market share).The Definition of Supply and Perfect CompetitionOther conditions make it impossible for any firm to forget about the hundreds of other firms waiting to replace their supply.A firm's goal is specified by the condition of profit maximization.The Definition of Supply and Perfect CompetitionEven if the conditions for a perfectly competitive market are not met, supply forces are still strong and many of the insights of the competitive model can be applied to firm behavior in other market structures.Demand Curves for the Firm and the IndustryThe demand curve facing the firm is different from the industry demand curve.A perfectly competitive firm’s demand is horizontal (perfectly elastic), even though the demand curve for the industry is downward sloping.Demand Curves for the Firm and the IndustryEach firm in a competitive industry is so small that it does not need to lower its price in order to sell additional output.Market supplyMarketdemand 1,0003,000Price$1086420QuantityMarketFirmIndividual firm demand Market Demand Curve Versus Individual Firm Demand Curve, Fig 11-1(a and b), p 236102030Price$1086420QuantityABCThe Profit-Maximizing Level of OutputThe goal of the firm is to maximize profits.When it decides what quantity to produce it continually asks how changes in quantity would affect its profit.Profit-Maximizing Level of OutputSince profit is the difference between total revenue and total cost, what happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC).A firm maximizes profit when MC = MR.Profit-Maximizing Level of OutputMarginal revenue (MR) is the change in total revenue associated with a change in quantity.Marginal cost (MC) is the change in total cost associated with a one unit change in quantity.Marginal RevenueSince a perfect competitor accepts the market price as given, for a perfectly competitive firm marginal revenue is equal to price (MR = P).Marginal CostInitially, marginal cost falls and then begins to rise.How to Maximize ProfitTo maximize profits, a firm should produce where marginal cost equals marginal revenue.How to Maximize ProfitIf marginal revenue does not equal marginal cost, a firm can increase profit by changing output.The supplier will continue to produce as long as marginal cost is less than marginal revenue.How to Maximize ProfitThe supplier will cut back on production if marginal cost is greater than marginal revenue.Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.Marginal Cost, Marginal Revenue, and Price Fig. 11-2a, p. 237Price = MRQuantityTotal CostMarginal Cost35040    2835168    2035288    16353104    14354118    12355130    17356147    22357169    30358199    40359239    543510293 BCArea1P = D = MRCosts12345678910Quantity6050403020100AMCMarginal Cost, Marginal Revenue, and Price, Fig. 11-2b, p. 237Area 2The Marginal Cost Curve Is the Supply CurveThe marginal cost curve, above the point where price exceeds average variable cost, is the firm's supply curve The Marginal Cost Curve Is the Supply CurveThe MC curve tells the competitive firm how much it should produce at a given price.The firm can do no better than producing the quantity at which marginal cost equals price which in turn equals marginal revenue.The Marginal Cost Curve Is the Firm’s Supply Curve, Fig. 11-3, p. 239ACMarginal cost$7060504030201001Quantity2345678910BCost, PriceFirms Maximize Total ProfitFirms maximize total profit, not profit per unit.As long as an increase in output yields even a small amount of additional profit, a profit-maximizing firm will increase output.Profit Maximization Using Total Revenue and Total CostProfit is maximized where the vertical distance between total revenue and total cost is greatest.At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal.TCTR0$3853503152802452101751401057035Quantity123456789Profit Determination by Total Cost and Revenue Curves, Fig. 11-4b, p 240Maximum profit =$81$130LossLossProfitTotal cost, revenueTotal Profit at the Profit-Maximizing Level of OutputWhile the P = MR = MC condition tells us how much output a competitive firm should produce to maximize profit, it does not tell us the profit the firm makes.Determining Profit and Loss From a Table of CostsProfit can be calculated from a table of costs and revenues.Profit is determined by total revenue minus total cost.Determining Profit and Loss From a Table of CostsThe profit-maximizing output choice is not necessarily a position that minimizes either average variable cost or average total cost.It is only the choice that maximizes total profit.Costs Relevant to a Firm, Table 11-1, p 241Costs Relevant to a Firm, Table 11-1, p 241Determining Profit and Loss From a GraphFind output where MC = MR.The intersection of MC = MR (P) determines the quantity the firm will produce if it wishes to maximize profits.Determining Profit and Loss From a GraphFind profit per unit where MC = MR.To determine maximum profit, you must first determine what output the firm will choose to produce.See where MC equals MR, and then draw a line down to the ATC curve.This is the profit per unit.(a) Positive economic profit (b) Zero economic profit(c) Economic lossDetermining Profits Graphically, Fig. 11-5, p 243QuantityQuantityQuantityPrice65 60 55 50 45 40 35 30 25 20 15 10 5 065 60 55 50 45 40 35 30 25 20 15 10 5 01 2 3 4 5 6 7 8 9 10 121 2 3 4 5 6 7 8 9 10 12DMCAP = MRBATCAVCEProfitCMCATCAVCMCATCAVCLoss65 60 55 50 45 40 35 30 25 20 15 10 5 01 2 3 4 5 67891012P = MRP = MRPricePrice© The McGraw-Hill Companies, Inc., 2000Zero Profit or Loss Where MC=MRFirms can also earn zero profit or even a loss where MC = MR.Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.Zero Profit or Loss Where MC=MRIn all three cases (profit, loss, zero profit), determining the profit-maximizing output level does not depend on fixed cost or average total cost, but only where marginal cost equals price.The Role of Profits as Market Signals, Table 11-2, p 243Profit CalculationType of ProfitMarket Signal > 0Positive economic profit, or Economic profitEntry. Resources are drawn into the industry. = 0Zero economic profit, Zero profit, orNormal profitStatic. The industry is in long run equilibrium. < 0Economic lossExit. Resources leave the industry.The Shutdown PointThe firm will shut down if it cannot cover variable costs. A firm should continue to produce as long as price is greater than average variable cost.Once price falls below that point it will be cheaper to shut down temporarily and save the variable costs.The Shutdown PointThe shutdown point is the point at which the firm will be better off by shutting down than it will if it stays in business.The Shutdown PointAs long as total revenue is more than total variable cost, temporarily producing at a loss is the firm’s best strategy since it is taking less of a loss than it would by shutting down (loss minimization).MCP = MR2468QuantityPrice6050403020100ATCAVCLossA$17.80The Shutdown Decision, Fig.11-6a, p 245Long-Run Competitive Equilibrium, Fig.11-6b, p 245MCP = MR0605040302010Price2468QuantitySRATCLRATCShort-Run Market Supply and DemandWhile the firm's demand curve is perfectly elastic, the industry demand is downward sloping.Industry supply is the sum of all firms’ supply curves.Short-Run Market Supply and DemandIn the short run when the number of firms in the market is fixed, the market supply curve is just the horizontal sum of all the firms' marginal cost curves.Short-Run Market Supply and DemandSince all firms have identical marginal cost curves, a quick way of summing the quantities is to multiply the quantities from the marginal cost curve of a representative firm by the number of firms in the market.The market supplyIn the long run, the number of firms may change in response to market signals, such as price and profit.As firms enter the market in response to economic profits being made, the market supply shifts to the right.As economic losses force some firms to exit, the market supply shifts to the left.Long-Run Competitive EquilibriumProfits and losses are inconsistent with long-run equilibrium.Profits create incentives for new firms to enter, output will increase, and the price will fall until zero economic profits are made.Only zero economic profit will stop entry.Long-Run Competitive EquilibriumThe existence of losses will cause some firms to leave the industry.In a long run equilibrium firms make no economic profit (the zero profit condition).Long-Run Competitive EquilibriumZero profit does not mean that the entrepreneur does not get anything for his efforts.Long-Run Competitive EquilibriumIn order to stay in business the entrepreneur must receive his opportunity cost or normal profits (the amount the owners of business would have received in the next-best alternative).Long-Run Competitive EquilibriumNormal profits are included as a cost. Economic profits are profits above normal profits.Long-Run Competitive EquilibriumEven if some firm has super efficient workers or machines that produce rent, it will not take long for competitors to match these efficiencies and drive down the price, until all economic profits are eliminated.Long-Run Competitive EquilibriumThe zero profit condition is enormously powerful.As long as there is free entry and exit, price will be pushed down to the average total cost of production.Adjustment from the Short Run to the Long RunIndustry supply and demand curves come together to lead to long-run equilibrium.An Increase in DemandAn increase in demand leads to higher prices and higher profits.Existing firms increase output and new firms will enter the market, increasing industry output still more, price will fall until all profit is competed away.An Increase in DemandIf the the market is a constant-cost industry, the new equilibrium will be at the original price but with a higher market output.A market is a constant-cost industry if the long-run industry supply curve is perfectly elastic (horizontal).An Increase in DemandThe original firms return to their original output but since there are more firms in the market, the total market output increases.An Increase in DemandIn the short run, the price does more of the adjusting.In the long run, more of the adjustment is done by quantity.Profit$910120FirmPriceQuantityBAMarket Response to an Increase in Demand,Fig. 11-7, p 248MarketQuantityPrice0BACMCACSLRS0SRD07700$98401,200D1S1SR7Long-Run Market SupplyTwo other possibilities exist:Increasing-cost industry – factor prices rise as new firms enter the market and existing firms expand capacity.Decreasing-cost industry – factor prices fall as industry output expands.An Increasing-Cost IndustryIf inputs are specialized, factor prices are likely to rise when the increase in the industry-wide demand for inputs to production increases.An Increasing-Cost IndustryThis rise in factor costs would raise costs for each firm in the industry and increase the price at which firms earn zero profit (break even).An Increasing-Cost IndustryTherefore, in increasing-cost industries, the long-run supply curve is upward sloping.A Decreasing-Cost IndustryIf input prices decline when industry output expands, individual firms' cost curves shift down.The price at which firms break even now decreases, and the long-run market supply curve is downward sloping.An Example: Canadian Retail IndustryDuring the 1990s the Canadian retail industry illustrated how a competitive market adjusts to changing market conditions.An Example: Canadian Retail IndustryMany retailers were lost or absorbed by competitors: Eaton’s, Bretton’s, Pascal’s, Robinson’s, K-Mart and many others.Initially, these firms saw their losses as the temporary result of reduced demand in a slowing economy.An Example: Canadian Retail IndustryAs prices fell, P=MR fell below their ATC.But since price remained above the AVC, many firms closed their less profitable locations and continued to operate.An Example: Canadian Retail IndustryWhen demand did not recover, firms ran out of options.Many firms realized as they moved into the long run that they have to exit the Canadian retail industry.PriceQuantityMCATCAVCP = MRLossAn Example: A Shutdown Decision, Fig. 11-8, p 250Perfect CompetitionEnd of Chapter 11