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CHAPTER 12 Competition

CHAPTER 12 Competition. Competition. What is perfect competition? How are price and output determined in a competitive industry? Why do firms enter and leave an industry? How do changes in demand and technology affect an industry? Why is perfect competition economically efficient?.

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CHAPTER 12 Competition

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  1. CHAPTER12 Competition

  2. Competition • What is perfect competition? • How are price and output determined in a competitive industry? • Why do firms enter and leave an industry? • How do changes in demand and technology affect an industry? • Why is perfect competition economically efficient?

  3. Perfect Competition • Perfect competition arises when: • There are many firms, each selling an identical product. • There are many buyers. • There are no restrictions on entry into the industry. • Firms in the industry have no advantage over potential new entrants. • Firms and buyers are completely informed about other firms’ prices.

  4. The Firm Has No Control Over the Price It Charges • Since each firm produces a small fraction of total industry output and the products are identical, no firm has any control over price. • Firms are price takers in perfectly competitive markets. A price taker is a firm that cannot influence the price of a good or service.

  5. Elasticity of Industryand Firm Demand • A price taker firm faces a demand curve that is perfectly elastic (horizontal) because the product from firm A is a perfect substitute for the product from firm B. • However, the market demand curve will still slope downward; elasticity will be positive, but not infinite.

  6. Competition inthe Real World • In reality, there are no markets that are absolutely perfectly competitive. • However, competition in some industries is so fierce that the model of perfect competition predicts extremely well how firms will behave. • Examples are computers, soft drinks, TVs, DVD players, potato chips, etc.

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

  8. Economic Profit and Revenue Suppose Cindy sells her sweaters in a perfectly competitive market. What are Cindy’s TR, MR, and AR?

  9. 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

  10. 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 10 25

  11. 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

  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 25 200 9 25 225 10 25 250

  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 25 10 25 250

  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 - 9 25 225 25 10 25 250 25

  16. 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

  17. 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 25 10 25 250 25

  18. 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 25 10 25 250 25 25

  19. Demand, Price, and Revenuein Perfect Competition Cindy’s demand, average revenue, and marginal revenue Cindy’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)

  20. 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)

  21. Demand, Price, and Revenuein Perfect Competition Cindy’s demand, average revenue, and marginal revenue Sweater Industry Cindy’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)

  22. Demand, Price, and Revenuein Perfect Competition Cindy’s demand, average revenue, and marginal revenue Cindy’s total revenue SweaterIndustry TR Cindy’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)

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

  24. 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.

  25. 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 whether to leave or stay in the industry.

  26. 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. • Price is not a decision because firm is a price taker.

  27. 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.

  28. 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

  29. 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 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

  30. 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 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

  31. 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 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

  32. 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 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

  33. 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 6 150 126 7 175 141 8 200 160 9 225 183 10 250 210 11 275 245 12 300 300 13 325 360

  34. 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 7 175 141 8 200 160 9 225 183 10 250 210 11 275 245 12 300 300 13 325 360

  35. 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 8 200 160 9 225 183 10 250 210 11 275 245 12 300 300 13 325 360

  36. 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 34 8 200 160 9 225 183 10 250 210 11 275 245 12 300 300 13 325 360

  37. 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 34 8 200 160 40 9 225 183 10 250 210 11 275 245 12 300 300 13 325 360

  38. 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 34 8 200 160 40 9 225 18342 10 250 210 11 275 245 12 300 300 13 325 360

  39. 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 34 8 200 160 40 9 225 18342 10 250 210 40 11 275 245 12 300 300 13 325 360

  40. 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 34 8 200 160 40 9 225 18342 10 250 210 40 11 275 245 30 12 300 300 13 325 360

  41. 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 34 8 200 160 40 9 225 18342 10 250 210 40 11 275 245 30 12 300 300 0 13 325 360

  42. 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 34 8 200 160 40 9 225 18342 10 250 210 40 11 275 245 30 12 300 300 0 13 325 360 -35

  43. 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 34 8 200 160 40 9 225 183 42 10 250 210 40 11 275 245 30 12 300 300 0 13 325 360 -35

  44. 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)

  45. 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)

  46. 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)

  47. 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)

  48. 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

  49. 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

  50. Total Revenue, Total Cost,and Economic Profit MR>MC MR=MC MR<MC 42 Profit/loss (dollars per day) 20 0 Quantity (sweaters per day) 4 9 12 -20 Profit/ loss Profit maximizing quantity -40

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