Understanding Perfectly Competitive Markets: Demand, Profit, and Maximization

3. 11 CHAPTER Firms in Perfectly Competitive Markets The market for organically grown food has expanded rapidly in the United States. Prepared by: Fernando Quijano

4. 11 CHAPTER Chapter OutlineandLearning Objectives Firms in Perfectly Competitive Markets

5. Firms in Perfectly Competitive Markets Table 11-1 The Four Market Structures

6. Firms in Perfectly Competitive Markets Table 11-2 The Extended Four Market Structures

7. 11.1 LEARNING OBJECTIVE Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. Perfectly Competitive Markets Perfectly competitive market A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market. A Perfectly Competitive Firm Cannot Affect the Market Price Price taker A buyer or seller that is unable to affect the market price.

8. 11.1 LEARNING OBJECTIVE Perfectly Competitive Markets Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. The Demand Curve for the Output of a Perfectly Competitive Firm FIGURE 11-1 A Perfectly Competitive Firm Faces a Horizontal Demand Curve A firm in a perfectly competitive market is selling exactly the same product as many other firms. Therefore, it can sell as much as it wants at the current market price, but it cannot sell anything at all if it raises the price by even 1 cent. As a result, the demand curve for a perfectly competitive firm’s output is a horizontal line. In the figure, whether the wheat farmer sells 6,000 bushels per year or 15,000 bushels has no effect on the market price of $4.

9. 11.1 LEARNING OBJECTIVE • YOUR TURN: Test your understanding by doing related problem 1.6 at the end of this chapter. Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. Perfectly Competitive Markets The Demand Curve for the Output of a Perfectly Competitive Firm FIGURE 11-2 The Market Demand for Wheat versus the Demand for One Farmer’s Wheat In a perfectly competitive market, price is determined by the intersection of market demand and market supply. In panel (a), the demand and supply curves for wheat intersect at a price of $4 per bushel. An individual wheat farmer like Farmer Parker cannot affect the market price for wheat. Therefore, as panel (b) shows, the demand curve for Farmer Parker’s wheat is a horizontal line. Don’t Let This Happen to YOU!Don’t Confuse the Demand Curve for Farmer Parker’s Wheat with the Market Demand Curve for Wheat

10. 11.2 LEARNING OBJECTIVE Explain how a firm maximizes profit in a perfectly competitive market. How a Firm Maximizes Profitin a Perfectly Competitive Market Profit Total revenue minus total cost. Profit = TR – TC Revenue for a Firm in a Perfectly Competitive Market Average revenue (AR) Total revenue divided by the quantity of the product sold. Marginal revenue (MR) The change in total revenue from selling one more unit of a product.

11. 11.2 LEARNING OBJECTIVE Explain how a firm maximizes profit in a perfectly competitive market. How a Firm Maximizes Profitin a Perfectly Competitive Market Revenue for a Firm in a Perfectly Competitive Market Table 11-3 Farmer Parker’s Revenue from Wheat Farming

12. 11.2 LEARNING OBJECTIVE Explain how a firm maximizes profit in a perfectly competitive market. How a Firm Maximizes Profitin a Perfectly Competitive Market Determining the Profit-Maximizing Level of Output Table 11-4 Farmer Parker’s Profits from Wheat Farming

13. 11.2 LEARNING OBJECTIVE Explain how a firm maximizes profit in a perfectly competitive market. How a Firm Maximizes Profitin a Perfectly Competitive Market Determining the Profit-Maximizing Level of Output FIGURE 11-3 The Profit-Maximizing Level of Output Panel (b) shows that Farmer Parker’s marginal revenue (MR) is equal to a constant $4 per bushel. Farmer Parker maximizes profits by producing wheat up to the point where the marginal revenue of the last bushel produced is equal to its marginal cost, or MR = MC. In panel (a), Farmer Parker maximizes his profit where the vertical distance between total revenue and total cost is the largest.

14. 11.2 LEARNING OBJECTIVE Explain how a firm maximizes profit in a perfectly competitive market. How a Firm Maximizes Profitin a Perfectly Competitive Market Determining the Profit-Maximizing Level of Output From the information in Table 11-3 and Figure 11-3, we can draw the following conclusions: The profit-maximizing level of output is where the difference between total revenue and total cost is the greatest. The profit-maximizing level of output is also where marginal revenue equals marginal cost, or MR = MC.

15. 11.3 LEARNING OBJECTIVE Use graphs to show a firm’s profit or loss. Illustrating Profit or Loss onthe Cost Curve Graph Profit = (P x Q) TC or Profit = (PATC) x Q

16. 11.3 LEARNING OBJECTIVE Illustrating Profit or Loss onthe Cost Curve Graph Use graphs to show a firm’s profit or loss. Showing a Profit on the Graph FIGURE 11-4 The Area of Maximum Profit A firm maximizes profit at the level of output at which marginal revenue equals marginal cost. The difference between price and average total cost equals profit per unit of output. Total profit equals profit per unit multiplied by the number of units produced. Total profit is represented by the area of the green-shaded rectangle, which has a height equal to (P - ATC) and a width equal to Q.

17. 11.3 LEARNING OBJECTIVE Illustrating Profit or Losson the Cost Curve Graph • YOUR TURN:Test your understanding by doing related problem 3.5 at the end of this chapter. Use graphs to show a firm’s profit or loss. Don’t Let This Happen to YOU!Remember That Firms Maximize Their Total Profits, Not Their Profits per Unit

18. 11.3 LEARNING OBJECTIVE Illustrating Profit or Losson the Cost Curve Graph Use graphs to show a firm’s profit or loss. Illustrating When a Firm Is Breaking Even or Operating at a Loss P > ATC, which means the firm makes a profit. P = ATC, which means the firm breaks even (its total cost equals its total revenue). P < ATC, which means the firm experiences losses.

19. 11.3 LEARNING OBJECTIVE Illustrating Profit or Losson the Cost Curve Graph Use graphs to show a firm’s profit or loss. Illustrating When a Firm Is Breaking Even or Operating at a Loss FIGURE 11-5 A Firm Breaking Even and a Firm Experiencing Losses In panel (a), price equals average total cost, and the firm breaks even because its total revenue will be equal to its total cost. In this situation, the firm makes zero economic profit. In panel (b), price is below average total cost, and the firm experiences a loss. The loss is represented by the area of the red-shaded rectangle, which has a height equal to (ATC - P) and a width equal to Q.

20. 11.3 LEARNING OBJECTIVE MakingtheConnection • YOUR TURN:Test your understanding by doing related problem 3.8 at the end of this chapter. Use graphs to show a firm’s profit or loss. • Losing Money in the Medical Screening Industry

21. 11.4 LEARNING OBJECTIVE Explain why firms may shut down temporarily. Deciding Whether to Produceor to Shut Down in the Short Run In the short run, a firm experiencing losses has two choices: Continue to produce Stop production by shutting down temporarily Sunk cost A cost that has already been paid and that cannot be recovered.

22. 11.4 LEARNING OBJECTIVE MakingtheConnection • YOUR TURN:Test your understanding by doing related problems 4.5 and 4.6 at the end of this chapter. Explain why firms may shut down temporarily. • When to Close a Laundry Keeping a business open even when suffering losses can sometimes be the best decision for an entrepreneur in the short run.

23. MakingtheConnection • Perfectly Competitive Market 若某一市場上所有的廠商都是價格接受者，這稱為完全競爭市場(perfect competition market)1，舉例來說，台灣大街小巷都有飲料店販賣珍珠奶茶，每一家店的口味大致相同，同一地區各店家的珍珠奶茶訂價也相同(ex:臺北市師大夜市商圈的飲料店可能不下40家，幾乎每一家都有賣珍奶，大杯價格差不多30元)，因此一般飲料店可以視為是完全競爭廠商的例子。此外，相同品種的稻米、蔬菜與水果，也是完全競爭市場之產品，種植這些農產品的農夫也是價格接受者。 註1：沒有能力影響價格之廠商，又稱為完全競爭廠商。

24. 11.4 LEARNING OBJECTIVE Explain why firms may shut down temporarily. Deciding Whether to Produce or to Shut Down in the Short Run The Supply Curve of a Firm in the Short Run Total revenue < Variable cost, or, in symbols: (P × Q) < VC If we divide both sides by Q, we have the result that the firm will shut down if: P < AVC Shutdown point The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.

25. 11.4 LEARNING OBJECTIVE Deciding Whether to Produce or to Shut Down in the Short Run Explain why firms may shut down temporarily. The Supply Curve of a Firm in the Short Run FIGURE 11-6 The Firm’s Short-Run Supply Curve For any given price, we can determine the quantity of output the firm will supply from the marginal cost curve. In other words, the marginal cost curve is the firm’s supply curve. The firm will shut down if the price falls below average variable cost. The marginal cost curve crosses the average variable cost at the firm’s shutdown point. This point occurs at output level QSD. For prices below PMIN, the supply curve is a vertical line along the price axis, which shows that the firm will supply zero output at those prices. The red line in the figure is the firm’s short-run supply curve.

26. 11.4 LEARNING OBJECTIVE Deciding Whether to Produce or to Shut Down in the Short Run Explain why firms may shut down temporarily. The Market Supply Curve in a Perfectly Competitive Industry FIGURE 11-7 Firm Supply and Market Supply We can derive the market supply curve by adding up the quantity that each firm in the market is willing to supply at each price. In panel (a), one wheat farmer is willing to supply 15,000 bushels of wheat at a price of $4 per bushel. If every wheat farmer supplies the same amount of wheat at this price and if there are 167,000 wheat farmers, the total amount of wheat supplied at a price of $4 will equal 15,000 bushels per farmer × 167,000 farmers = 2.5 billion bushels of wheat.

27. 11.5 LEARNING OBJECTIVE Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision Table 11- 5 Farmer Moreno’s Costs per Year Economic profit A firm’s revenues minus all its costs, implicit and explicit.

28. 11.5 LEARNING OBJECTIVE Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision Economic Profit Leads to Entry of New Firms FIGURE 11-8 The Effect of Entry on Economic Profits

29. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision Economic Losses Lead to Exit of Firms FIGURE 11-9 The Effect of Exit on Economic Losses

30. 11.5 LEARNING OBJECTIVE Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision Economic Losses Lead to Exit of Firms FIGURE 11-9 The Effect of Exit on Economic Losses The Effect of Exit on Economic Losses (continued)

31. 11.5 LEARNING OBJECTIVE Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Economic Profit and the Entry or Exit Decision Economic Losses Lead to Exit of Firms Economic loss The situation in which a firm’s total revenue is less than its total cost, including all implicit costs. Long-Run Equilibrium in a Perfectly Competitive Market Long-run competitive equilibrium The situation in which the entry and exit of firms has resulted in the typical firm breaking even.

32. 11.5 LEARNING OBJECTIVE Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run The Long-Run Supply Curve in a Perfectly Competitive Market FIGURE 11-10 The Long-Run Supply Curve in a Perfectly Competitive Industry

33. 11.5 LEARNING OBJECTIVE Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run The Long-Run Supply Curve in a Perfectly Competitive Market Long-run supply curve A curve that shows the relationship in the long run between market price and the quantity supplied. Increasing-Cost and Decreasing-Cost Industries Industries with upward-sloping long-run supply curves are called increasing-cost industries. Industries with downward-sloping long-run supply curves are called decreasing-cost industries.

34. 11.5 LEARNING OBJECTIVE MakingtheConnection • YOUR TURN:Test your understanding by doing related problem 6.4 at the end of this chapter. Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. • Easy Entry Makes the Long Run Pretty Short in the Apple iPhone Apps Store In a competitive market, earning an economic profit in the long run is extremely difficult. And the ease of entering the market for iPhone apps has made the long run pretty short. Economic profits are rapidly competed away in the iPhone apps store.

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36. 11.6 LEARNING OBJECTIVE Explain how perfect competition leads to economic efficiency. Perfect Competition and Efficiency Productive Efficiency Productive efficiency The situation in which a good or service is produced at the lowest possible cost.

37. 11.6 LEARNING OBJECTIVE Explain how perfect competition leads to economic efficiency. Perfect Competition and Efficiency Allocative Efficiency Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them. The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit. Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

38. 11.6 LEARNING OBJECTIVE Explain how perfect competition leads to economic efficiency. Perfect Competition and Efficiency Allocative Efficiency Allocative efficiency A state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginalcost of producing it.

39. AN INSIDELOOK It Isn’t Easy—or Cheap—to Be Green >> Figure 2 The demand for a product increases after it is “green certified.” The marginal cost and average total cost curves shift up due to the cost of certification. Figure 1 The demand for a product increases after it is “green certified.” The graph assumes that the firm did not spend money to acquire certification for its product.

40. KEY TERMS Perfectly competitive market Price taker Productive efficiency Profit Shutdown point Sunk cost Allocative efficiency Average revenue (AR) Economic loss Economic profit Long-run competitive equilibrium Long-run supply curve Marginal revenue (MR)