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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
Chapter 7. Perfect Competition
  • What is it?
  • Firm behavior
  • Short run
  • Long run
perfect competition
Perfect Competition
  • many firms, many buyers
  • identical product
  • easy entry/exit for the market
  • prices known
  • existing firms have no advantage
examples
examples
  • wheat farming
  • dry cleaning
  • paper cups
firm behavior
Firm Behavior
  • maximize profits
  • TR > TC
    • economic profits
  • TR = TC
    • normal profits
firm is price taker
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
profit maximizing
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

firm s demand cost curve

P

MC

Q (cans/day)

10

Firm’s demand, cost curve

D = MR = P

$8

slide9
firm is price taker
  • what if price too low to earn profit?
    • economic loss
    • will firm exit?
costs exit
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

sr equilibrium
SR equilibrium
  • two cases
    • economic profit
    • economic loss
case 1 economic profit
Case 1: economic profit
  • P = $8, Q = 10
  • ATC = $5
  • profit = ($8)(10) - ($5)(10) = $30
slide13

economic

profit

P

MC

ATC

$5

Q (cans/day)

10

D = MR = P

$8

case 2 economic loss
case 2: economic loss
  • P = $3, Q = 7
  • ATC = $5
  • profit = ($3)(7) - ($5)(7) = - $14
slide15

economic

loss

P

MC

ATC

$5

Q (cans/day)

7

D = MR = P

$3

12 3 lr equilibrium
12.3 LR Equilibrium
  • entry & exit of firms
  • firms earn normal profit
    • economic profit will be zero
why zero economic profit
why zero economic profit?
  • if economic profit > zero
    • firms enter (S shifts right)
    • price falls
    • profit falls to zero
market for syrup

P

S

S’

$8

$5

D

Q (cans/day)

100

120

market for syrup
syrup firm

zero

economic

profit

P

MC

ATC

$5

Q (cans/day)

Syrup firm

D = MR = P

slide20
if economic profit < zero
    • firms exit (S shifts left)
    • price rises
    • profit rises to zero
market for syrup21

P

S

S’’

$5

$3

D

Q (cans/day)

120

140

market for syrup
slide22

economic

loss

P

MC

ATC

$5

Q (cans/day)

7

D = MR = P

$3

syrup firm23

zero

economic

profit

P

MC

ATC

$5

Q (cans/day)

Syrup firm

D = MR = P

shifts in market demand
Shifts in market demand
  • change price in SR
    • profits or losses
  • in LR affect exit/entry
    • return to zero economic profit
summary
Summary
  • price takers
  • MR = MC determines equilibrium Q
    • SR: economic profit or loss
    • LR: economic profit is zero due

to entry/exit