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CHAPTER 12 Competition
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  1. CHAPTER12Competition

  2. Learning Objectives • Define perfect competition • Explain how price and output are determined in a competitive industry • Explain why firms sometimes shut down temporarily and lay off workers

  3. Learning Objectives (cont.) • Explain why firms enter and leave an industry • Predict the effects of a change in demand and of a technological advance • Explain why perfect competition is efficient

  4. Learning Objectives • Define perfect competition • Explain how price and output are determined in a competitive industry • Explain why firms sometimes shut down temporarily and lay off workers

  5. Perfect Competition • Characteristics of Perfect Competition • Many firms, each selling an identical product • Many buyers • No restrictions on entry into the industry

  6. Perfect Competition • Characteristics of Perfect Competition • Firms in the industry have no advantage over potential new entrants • Firms and buyers are well informed about prices of the products of each firm in the industry

  7. Perfect Competition • As a result of these characteristics, perfect competitors are price takers. • Price takers • firms that cannot influence the price of a good or service.

  8. Learning Objectives • Define perfect competition • Explain how price and output are determined in a competitive industry • Explain why firms sometimes shut down temporarily and lay off workers

  9. Economic Profit and Revenue • The firm’s goal is to maximize economic profit. • Total cost is the opportunity cost — including normal profit.

  10. Economic Profit and Revenue • Total revenue is the value of a firm’s sales • Total revenue = P ´ Q • Marginal revenue(MR) • Change in total revenue resulting from a one-unit increase in quantity sold. • Average revenue(AR) • Total revenue divided by the quantity sold — revenue per unit sold. • In perfect competition, Price = MR = AR

  11. Economic Profit and Revenue Suppose Swanky sells his sweaters in a perfectly competitive market.

  12. Demand, Price, and Revenuein Perfect Competition Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue (AR = TR/Q (sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater) 8 25 9 25 10 25

  13. Demand, Price, and Revenuein Perfect Competition Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue (AR = TR/Q (sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater) 8 25 200 9 25 225 10 25 250

  14. Demand, Price, and Revenuein Perfect Competition Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue (AR = TR/Q (sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater) 8 25 200 9 25 225 10 25 250 25 25

  15. Demand, Price, and Revenuein Perfect Competition Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue (AR = TR/Q (sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater) 8 25 200 25 9 25 225 25 10 25 250 25 25 25

  16. Demand, Price, and Revenuein Perfect Competition Swanky’s demand, average revenue, and marginal revenue Swanky’s total revenue SweaterIndustry 50 50 Total revenue (dollar per day) Price (dollars per sweater) Price (dollars per sweater) 25 225 25 0 9 20 0 10 20 0 9 20 Quantity (thousands of sweaters per day) Quantity (sweaters per day) Quantity (sweaters per day)

  17. Demand, Price, and Revenuein Perfect Competition Sweater Industry 50 50 Total revenue (dollar per day) S Price (dollars per sweater) Price (dollars per sweater) 25 225 25 D 0 9 20 0 10 20 0 9 20 Quantity (thousands of sweaters per day) Quantity (sweaters per day) Quantity (sweaters per day)

  18. Demand, Price, and Revenuein Perfect Competition Swanky’s demand, average revenue, and marginal revenue Sweater Industry Swanky’s demand curve 50 50 Total revenue (dollar per day) S Price (dollars per sweater) Price (dollars per sweater) AR= MR 25 225 25 D 0 9 20 0 10 20 0 9 20 Quantity (thousands of sweaters per day) Quantity (sweaters per day) Quantity (sweaters per day)

  19. Demand, Price, and Revenuein Perfect Competition Swanky’s demand, average revenue, and marginal revenue Swanky’s total revenue SweaterIndustry TR Swanky’s demand curve 50 50 Total revenue (dollar per day) S Price (dollars per sweater) Price (dollars per sweater) AR= MR 25 225 25 a D 0 9 20 0 10 20 0 9 20 Quantity (thousands of sweaters per day) Quantity (sweaters per day) Quantity (sweaters per day)

  20. Learning Objectives • Define perfect competition • Explain how price and output are determined in a competitive industry • Explain why firms sometimes shut down temporarily and lay off workers

  21. The Firm’s Decisions inPerfect Competition • A firm’s task is to make the maximum economic profit possible, given the constraints it faces. • In order to do so, the firm must make two decisions in the short-run, and two in the long-run.

  22. The Firm’s Decisions inPerfect Competition • Short-run • A time frame in which each firm has a given plant and the number of firms in the industry is fixed • Long run • A time frame in which each firm can change the size of its plant and decide to enter the industry.

  23. The Firm’s Decisions inPerfect Competition • In the short-run, the firm must decide: • Whether to produce or to shut down. • If the decision is to produce, what quantity to produce.

  24. The Firm’s Decisions inPerfect Competition • In the long-run, the firm must decide: • Whether to increase of decrease its plant size • Whether to stay in the industry or leave it We will first address the short-run.

  25. Total Revenue, Total Cost,and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0 0 1 25 2 50 3 75 4 100 5 125 6 150 7 175 8 200 9 225 10 250 11 275 12 300 13 325

  26. Total Revenue, Total Cost,and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0 0 22 1 25 45 2 50 66 3 75 85 4 100 100 5 125 114 6 150 126 7 175 141 8 200 160 9 225 183 10 250 210 11 275 245 12 300 300 13 325 360

  27. Total Revenue, Total Cost,and Economic Profit Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC) Per day) (dollars) (dollars) (dollars) 0 0 22 -22 1 25 45 -20 2 50 66 -16 3 75 85 -10 4 100 100 0 5 125 114 11 6 150 126 24 7 175 141 24 8 200 160 40 9 225 183 42 10 250 210 40 11 275 245 30 12 300 300 0 13 325 360 -35

  28. Total Revenue, Total Cost,and Economic Profit Revenue and Cost Total revenue & total cost (dollars per day) 300 225 183 100 0 4 9 12 Quantity (sweaters per day)

  29. Total Revenue, Total Cost,and Economic Profit Revenue and Cost TR Total revenue & total cost (dollars per day) 300 225 183 100 0 4 9 12 Quantity (sweaters per day)

  30. Total Revenue, Total Cost,and Economic Profit TC Revenue and Cost TR Total revenue & total cost (dollars per day) 300 225 183 100 0 4 9 12 Quantity (sweaters per day)

  31. Total Revenue, Total Cost,and Economic Profit TC Revenue and Cost TR Total revenue & total cost (dollars per day) 300 225 Economic profit = TR - TC 183 100 Economic loss 0 4 9 12 Quantity (sweaters per day)

  32. Total Revenue, Total Cost,and Economic Profit Economic profit/loss 42 Profit/loss (dollars per day) 20 0 Quantity (sweaters per day) 4 9 12 -20 Profit/ loss -40

  33. Total Revenue, Total Cost,and Economic Profit Economic profit/loss 42 Profit/loss (dollars per day) 20 0 Quantity (sweaters per day) 4 9 12 -20 Profit/ loss -40

  34. Total Revenue, Total Cost,and Economic Profit Economic profit/loss 42 Profit/loss (dollars per day) Economic profit Economic loss 20 0 Quantity (sweaters per day) 4 9 12 -20 Profit/ loss Profit maximizing quantity -40

  35. Marginal Analysis • Using marginal analysis, a comparison is made between a units marginal revenue and marginal cost.

  36. Marginal Analysis • If MR > MC, the extra revenue from selling one more unit exceeds the extra cost. • The firm should increase output to increase profit • If MR < MC, the extra revenue from selling one more unit is less than the extra cost. • The firm should decrease output to increase profit • If MR = MC economic profit is maximized.

  37. Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q) revenue (dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day) (dollars) sweater) (dollars sweater) (dollars) 7 175 8 200 9 225 10 250 11 275

  38. Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q) revenue (dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day) (dollars) sweater) (dollars sweater) (dollars) 7 175 8 200 9 225 10 250 11 275 25 25 25 25

  39. Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q) revenue (dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day) (dollars) sweater) (dollars sweater) (dollars) 7 175 141 8 200 160 9 225 183 10 250 210 11 275 245 25 25 25 25

  40. Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q) revenue (dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day) (dollars) sweater) (dollars sweater) (dollars) 7 175 141 8 200 160 9 225 183 10 250 210 11 275 245 25 25 25 25 19 23 27 35

  41. Profit-Maximizing Output Marginal Marginal revenue cost Quantity Total (MR) Total (MC) Economic (Q) revenue (dollars per cost (dollars per profit (sweaters (TR) additional (TC) additional (TR – TC) per day) (dollars) sweater) (dollars sweater) (dollars) 7 175 141 34 8 200 160 40 9225183 42 10 250 210 40 11 275 245 30 25 25 25 25 19 23 27 35

  42. Profit-Maximizing Output 30 25 Marginal revenue & marginal cost (dollars per day) 20 10 8 9 10 Quantity (sweaters per day)

  43. Profit-Maximizing Output 30 MR 25 Marginal revenue & marginal cost (dollars per day) 20 10 8 9 10 Quantity (sweaters per day)

  44. Profit-Maximizing Output MC 30 MR 25 Marginal revenue & marginal cost (dollars per day) 20 10 8 9 10 Quantity (sweaters per day)

  45. Profit-Maximizing Output Profit- maximization point MC Loss from 10th sweater 30 MR 25 Marginal revenue & marginal cost (dollars per day) Profit from 9th sweater 20 10 8 9 10 Quantity (sweaters per day)

  46. The Firm’s Short-Run Supply Curve • Fixed costs must be paid in the short-run. • Variable-costs can be avoided by laying off workers and shutting down. • Firms shut down if price falls below the minimum of average variable cost.

  47. A Firm’s Supply Curve 31 Marginal revenue & marginal cost (dollars per day) 25 17 7 9 10 Quantity (sweaters per day)

  48. A Firm’s Supply Curve 31 Marginal revenue & marginal cost (dollars per day) 25 AVC 17 7 9 10 Quantity (sweaters per day)

  49. A Firm’s Supply Curve MC 31 Marginal revenue & marginal cost (dollars per day) 25 AVC 17 7 9 10 Quantity (sweaters per day)

  50. A Firm’s Supply Curve MC 31 Marginal revenue & marginal cost (dollars per day) MR1 25 AVC 17 7 9 10 Quantity (sweaters per day)