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Chapter 7. Perfect Competition

Chapter 7. Perfect Competition. What is it? Firm behavior Short run Long run. Perfect Competition. many firms, many buyers identical product easy entry/exit for the market prices known existing firms have no advantage. examples. wheat farming dry cleaning paper cups. Firm Behavior.

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Chapter 7. Perfect Competition

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  1. Chapter 7. Perfect Competition • What is it? • Firm behavior • Short run • Long run

  2. Perfect Competition • many firms, many buyers • identical product • easy entry/exit for the market • prices known • existing firms have no advantage

  3. examples • wheat farming • dry cleaning • paper cups

  4. Firm Behavior • maximize profits • TR > TC • economic profits • TR = TC • normal profits

  5. Firm is price taker • cannot influence price • take price as given, choose Q • firm demand is perfectly elastic • horizontal line • MR = P • firm sells all it wants at price, P

  6. Profit maximizing • firm chooses Q to max profits • where TR - TC is largest -- where MR = MC • why MR = MC? • MR > MC -- output adding to profit • MR < MC -- output taking away from profit

  7. P S $8 D Q (cans/day) 100 Market for syrup (all firms)

  8. P MC Q (cans/day) 10 Firm’s demand, cost curve D = MR = P $8

  9. firm is price taker • what if price too low to earn profit? • economic loss • will firm exit?

  10. costs & exit • firm will stay, in SR, if • P > AVC • why? • if firm exits, loses TFC • if P = AVC -- loss from staying = loss from exit

  11. SR equilibrium • two cases • economic profit • economic loss

  12. Case 1: economic profit • P = $8, Q = 10 • ATC = $5 • profit = ($8)(10) - ($5)(10) = $30

  13. economic profit P MC ATC $5 Q (cans/day) 10 D = MR = P $8

  14. case 2: economic loss • P = $3, Q = 7 • ATC = $5 • profit = ($3)(7) - ($5)(7) = - $14

  15. economic loss P MC ATC $5 Q (cans/day) 7 D = MR = P $3

  16. 12.3 LR Equilibrium • entry & exit of firms • firms earn normal profit • economic profit will be zero

  17. why zero economic profit? • if economic profit > zero • firms enter (S shifts right) • price falls • profit falls to zero

  18. P S S’ $8 $5 D Q (cans/day) 100 120 market for syrup

  19. zero economic profit P MC ATC $5 Q (cans/day) Syrup firm D = MR = P

  20. if economic profit < zero • firms exit (S shifts left) • price rises • profit rises to zero

  21. P S S’’ $5 $3 D Q (cans/day) 120 140 market for syrup

  22. economic loss P MC ATC $5 Q (cans/day) 7 D = MR = P $3

  23. zero economic profit P MC ATC $5 Q (cans/day) Syrup firm D = MR = P

  24. Shifts in market demand • change price in SR • profits or losses • in LR affect exit/entry • return to zero economic profit

  25. Summary • price takers • MR = MC determines equilibrium Q • SR: economic profit or loss • LR: economic profit is zero due to entry/exit

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