Chapter 9
Chapter 9
Chapter 9
Perfectly
Competitive
Markets
Chapter Nine Overview
1.1. Introduction
Introduction
2.2. Perfect
PerfectCompetition
CompetitionDefined
Defined
3.3. The
TheProfit
ProfitMaximization
MaximizationHypothesis
Hypothesis
4.4. The
TheProfit
ProfitMaximization
MaximizationCondition
Condition
5.5. Short
ShortRun
RunEquilibrium
Equilibrium
•• Short
ShortRun
RunSupply
SupplyCurve
Curvefor
forthe
theFirm
Firm
•• Short
ShortRun
RunMarket
MarketSupply
SupplyCurve
Curve
•• Short
ShortRun
RunPerfectly
PerfectlyCompetitive
CompetitiveEquilibrium
Equilibrium
•• Producer
ProducerSurplus
Surplus
6.6. Long
LongRun
RunEquilibrium
Equilibrium
•• Long
LongRun
RunEquilibrium
EquilibriumConditions
Conditions
•• Long
LongRun
RunSupply
SupplyCurve
Curve
2
Chapter Nine
Perfectly Competitive Markets
AA perfectly
perfectly competitive
competitive market
market consists
consists of of firms
firms
that
that produce
produce identical
identical products
products that
that sell
sell at
at the
the same
same
price.
price.
Each
Each firm’s
firm’s volume
volume ofof output
output isis so
so small
small in
in
comparison
comparison to to the
the overall
overall market
market demand
demand thatthat no
no
single
singlefirm
firmhas
hasananimpact
impacton
onthe
themarket
marketprice.
price.
3
Chapter Nine
Perfectly Competitive Markets - Conditions
A.
A. Firms
Firms produce
produce undifferentiated
undifferentiated
products
products in
in the
the sense
sense that
that consumers
consumers
perceive
perceivethem
themto tobebeidentical
identical
B.
B. Consumers
Consumers have
have perfect
perfect
information
informationabout
aboutthe
theprices
pricesall
allsellers
sellers
in
inthe
themarket
marketcharge
charge
4
Chapter Nine
Perfectly Competitive Markets - Conditions
C.
C.Each
Eachbuyer’s
buyer’spurchases
purchasesare
areso
sosmall
small
that
that he/she
he/she has
has anan imperceptible
imperceptible
effect
effecton
onmarket
marketprice.
price.
D.
D.Each
Eachseller’s
seller’ssales
salesare
areso
so small
smallthat
that
he/she
he/shehas
hasananimperceptible
imperceptibleeffect
effectonon
market
market price.
price. Each
Each seller’s
seller’s input
input
purchases
purchases are
are so
so small
small that
that he/she
he/she
perceives
perceivesno
noeffect
effecton
oninput
inputprices
prices
E.E. All
All firms
firms (industry
(industry participants
participants and
and
new
new entrants)
entrants) have
have equal
equal access
access to
to
resources
resources(technology,
(technology,inputs).
inputs).
5
Chapter Nine
Implications of Conditions
6
Chapter Nine
The Profit Maximization Hypothesis
Definition:
Definition: Economic
EconomicProfit
Profit
Sales
SalesRevenue
Revenue--Economic
Economic(Opportunity)
(Opportunity)Cost
Cost
Example:
Example:
••Revenues:
Revenues:$1M
$1M
••Costs
Costsof
ofsupplies
suppliesand
andlabor:
labor:$850,000
$850,000
••Owner’s
Owner’sbest
bestoutside
outsideoffer:
offer:$200,000
$200,000
7
Chapter Nine
The Profit Maximization Hypothesis
8
Chapter Nine
The Profit Maximization Condition
IfIfPP>>MC
MCthen
thenprofit
profitrises
risesififoutput
outputisisincreased
increased
IfIfPP<<MC
MCthen
thenprofit
profitfalls
fallsififoutput
outputisisincreased.
increased.
Therefore,
Therefore, the
the profit
profit maximization
maximization condition
condition for
for aa
price-taking
price-takingfirm
firmisisPP==MC
MC
11
Chapter Nine
The Profit Maximization Condition
12
Chapter Nine
The Profit Maximization Condition
1. P = MC = MR
2. MC rising
13
Chapter Nine
Short Run Equilibrium
For
For the
the following,
following, the
the short
short run
run isis the
the period
period of
of time
time in
in which
which
the
the firm’s
firm’s plant
plant size
size isis fixed
fixed and
and the
the number
number ofof firms
firms in
in the
the
industry
industryisisfixed.
fixed.
STC(Q)
STC(Q)==SFC
SFC++NSFC
NSFC++TVC(q)
TVC(q)for
forqq>>00
STC(Q)
STC(Q)==SFC
SFCfor
forqq==00
14
Chapter Nine
Short Run Equilibrium
SFC is the cost of the firm’s fixed input that are unavoidable at q = 0
NSFC is the cost of the firm’s inputs that are avoidable if the firm
produces zero (salaries of some employees, for example)
15
Chapter Nine
Short Run Supply Curve (SRSC)
16
Chapter Nine
Shut Down Price
The firm will choose to produce a positive output only if:
Pq – TVC(q) > 0
P > AVC(q)
Definition:
Definition: The
The price
price below
below which
which the
the firm
firm would
would optopt to
to
produce
producezero
zeroisiscalled
calledthe
theshut
shutdown
downprice,
price,Ps.
Ps. In
Inthis
thiscase,
case,Ps
Psisis
the
theminimum
minimumpointpointononthe
theAVC
AVCcurve.
curve.
17
Chapter Nine
Short Run Supply Function
2. 0 where P < Ps
18
Chapter Nine
Short Run Supply Curve
$/yr NSFC
NSFC==00
SMC
SAC
AVC
Ps
Quantity (units/yr)
19
Chapter Nine
Cost Considerations
Example:
Example:
STC(q)
STC(q)==100
100++20q
20q++qq2
2
TFC
TFC ==100
100 (this
(thisisissunk)
sunk)
TVC(q)
TVC(q)==20q
20q++qq2
2
AVC(q)
AVC(q)==20
20++qq
SMC(q)
SMC(q)==2020++2q
2q
20
Chapter Nine
Cost Considerations
The minimum level of AVC is the point where AVC = SMC or:
20+q = 20+2q
q=0
AVC minimized at 20
P < Ps = 20: qs = 0
21
Chapter Nine
SRSC When Some Costs are Sunk and Some are Non-Sunk
22
Chapter Nine
SRSC When All Costs are Non-Sunk
23
Chapter Nine
SRSC When All Costs are Non-Sunk
$/yr
SMC
SAC
Ps AVC
Quantity (units/yr)
24
Chapter Nine
SRSC When All Costs are Non-Sunk
STC(q) = F + 20q + q2
AVC(q) = 20 + q
SMC(q) = 20 + 2q
SAC(q) = 100/q + 20 + q
SAC = SMC at q = 10
At
Atany
anyPP>>40,
40,the
thefirm
firmearns
earnspositive
positiveeconomic
economicprofit
profit
At
Atany
anyPP<<40,
40,the
thefirm
firmearns
earnsnegative
negativeeconomic
economicprofit.
profit.
25
Chapter Nine
Market Supply and Equilibrium
Definition:
Definition: The
The market
market supply
supply at
at any
any price
price isis the
the
sum
sum ofof the
the quantities
quantities each
each firm
firm supplies
supplies at
at that
that
price.
price.
The
The short
short run
run market
market supply
supply curve
curve isis the
the
horizontal
horizontal sum
sum of
of the
the individual
individual firm
firm supply
supply
curves.
curves.
26
Chapter Nine
Short Run market & Supply Curves
27
Chapter Nine
Short Run Perfectly Completive Equilibrium
s ( P) Qd ( P)
Q i
i 1
28
Chapter Nine
Short Run Perfectly Completive Equilibrium
29
Chapter Nine
Short Run Market Equilibrium
30
Chapter Nine
Deriving a Short Run Market Equilibrium
300
300Identical
IdenticalFirms
Firms
QQdd(P)
(P)==60
60––PP
STC(q)
STC(q)==0.1 0.1++150q
2
150q2
SMC(q)
SMC(q)==300q 300q
NSFC
NSFC==00
AVC(q)
AVC(q)==150q150q
31
Chapter Nine
Deriving a Short Run Market Equilibrium
Qs(P) = Qd(P) P = 60 – P
P*= 30
q* = 30/300=.1
Q* = 30
32
Chapter Nine
Deriving a Short Run Market Equilibrium
33
Chapter Nine
Comparative Statics
If Supply shifts
when number
of firms
increase
34
Chapter Nine
Comparative Statics
35
Chapter Nine
Long Run Market Equilibrium
36
Chapter Nine
Long Run Market Equilibrium
$/unit MC
SMC0 AC
P SAC0
SAC1
Example:
Example: Incentive
Incentiveto
to
Change
ChangePlant
PlantSize
Size
SMC1
For
Forexample,
example,atatP,P,this
thisfirm
firmhas
hasan
anincentive
incentivetotochange
changeplant
plantsize
sizetotolevel
levelKK1 1from
fromKK0:0:
q (000 units/yr)
1.8 6
37
Chapter Nine
Firm’s Long Run Supply Curve
The firm’s long run supply curve:
P = MC for P > (min(AC) = Ps)
0 (exit) for P < (min(AC) = Ps)
• For prices
greater that
$0.20 the long-
run supply curve
is the long-run
MC curve.
38
Chapter Nine
Long Run Market Equilibrium
A long run perfectly competitive equilibrium occurs at a market price,
P*, a number of firms, n*, and an output per firm, q* that satisfies:
Long
Longrun
runprofit
profitmaximization
maximizationwith
withrespect
respectto
tooutput
output
and
andplant
plantsize:
size:
P*
P*==MC(q*)
MC(q*)
Zero
Zeroeconomic
economicprofit
profit
P*
P*==AC(q*)
AC(q*)
Demand
Demandequals
equalssupply
supply
QQdd(P*)
(P*)==n*q*
n*q*…or…
…or…
n*
n*==QQd(P*)/q*
d
(P*)/q*
39
Chapter Nine
Long Run Perfectly Competitive
$/unit $/unit
n* = 10,000,000/50,000=200
MC Market demand
SAC AC
P*
SMC
q*=50,000 q Q*=10M. Q
40
Chapter Nine
Calculating Long Run Equilibrium
TC(q)
TC(q)==40q
40q--qq2++.01q
2
.01q3
3
AC(q) = 40 – q + .01q
AC(q) = 40 – q + .01q
22
MC(q)
MC(q)==4040––2q
2q++.03q
.03q2
2
QQdd(P)
(P)==25000-1000P
25000-1000P
The
Thelong
longrun
runequilibrium
equilibriumsatisfies
satisfiesthe
the
following:
following:
a.a.P*
P*==40
40––2q*
2q*--.03q*
2
.03q*2
b. P* = 40 – q* + .01q*
b. P* = 40 – q* + .01q*
22
c.c.25000-1000P*
25000-1000P*==q*n* q*n*
41
Chapter Nine
Calculating Long Run Equilibrium
Using
Using(a)
(a)and
and(b),
(b),we
wehave:
have:
40
40––2q*
2q*++.03q*
.03q*2==40-q*+.01q*
2
40-q*+.01q*2
2
q*
q*==50
50
P*
P*==15
15
QQdd(P*)
(P*)==10000
10000
Using
Using(c(c))we
wehave:
have:
n*
n*==10000/50
10000/50==200
200
42
Chapter Nine
Calculating Long Run Equilibrium
Summarizing
Summarizing long
long run run equilibrium
equilibrium –– “If
“If
anyone
anyone can
can do
do it,
it, you
you can’t
can’t make
make money
money at
at
it”
it”
Or
Orififthe
thefirm’s
firm’sstrategy
strategyisisbased
basedononskills
skillsthat
that
can
can bebe easily
easily imitated
imitated or
or resources
resources that
that can
can
be
be easily
easily acquired,
acquired, inin the
the long
long run
run your
your
economic
economicprofit
profitwill
willbe
becompeted
competedaway.
away.
43
Chapter Nine
Long Run Market Supply Curve
We
We have
have calculated
calculated aa point
point at
at which
which the
the
market
market willwill be
be inin long
long run
run equilibrium.
equilibrium.
This
This isis aa point
point on on the
the long
long run
run market
market
supply
supply curve.
curve. This
This curve
curve can
can be
be derived
derived
explicitly,
explicitly,however.
however.
Definition:
Definition: TheThe Long
Long Run
Run Market
Market Supply
Supply
Curve
Curve tells
tells us
us the
the total
total quantity
quantity of
of output
output
that
that will
will bebe supplied
supplied at at various
various market
market
prices,
prices, assuming
assuming that that all all long
long runrun
adjustments
adjustments(plant,
(plant,entry)
entry)take
takeplace.
place.
44
Chapter Nine
Long Run Market Supply Curve
Since new entry can occur in the long run, we cannot obtain the long run
market supply curve by summing the long run supplies of current market
participants
If P < min(AC), firms would earn negative profits and would supply nothing
45
Chapter Nine
Long Run Market Supply Curve
$/unit $/unit
n** = 18M/52,000 = 360
SS0 SS1
D1
MC D0
SAC AC
23
15 LS
SMC
q (000s)
50 52 10 18 46
Chapter Nine Q (M.)
Constant Cost Industry
• Constant-cost
Industry: An
industry in
which the
increase or
decrease of
industry output
does not affect
the price of
inputs.
47
Chapter Nine
Increasing Cost Industry
• Increasing cost Industry: An industry which increases in industry
output increase the price of inputs. Especially if firms use industry
specific inputs i.e. scarce inputs that are used only by firms in a
particular industry and no other industry.
48
Chapter Nine
Decreasing Cost Industry
49
Chapter Nine
Economic Rent
50
Chapter Nine
Economic Rent
51
Chapter Nine
Producer Surplus
Definition:
Definition: Producer
Producer Surplus
Surplus isis the
the area
area above
above the the market
market
supply
supply curve
curve and
and below
below the
the market
market price.
price. ItIt isis aa monetary
monetary
measure
measureof ofthe
thebenefit
benefitthat
thatproducers
producersderive
derivefrom
fromproducing
producingaa
good
goodatataaparticular
particularprice.
price.
…that the producer earns the price for every unit sold,
but only incurs the SMC for each unit. This is why the
difference between the P and SMC curve measures the
total benefit derived from production.
52
Chapter Nine
Producer Surplus
53
Chapter Nine
Producer Surplus
P
P*
Producer Surplus
Chapter Nine
Q 54
Producer Surplus
• Producer surplus is area FBCE when price is $3.50
55
Chapter Nine
Producer Surplus
Q 60 P
• Given Market
supply curve and P
is the price in
dollars per gallon
• Find producer
surplus when price
is $2.50 per gallon
• How much does
producer surplus
when price of milk
increases from
$2.50 to $4.00
56
Chapter Nine
Producer Surplus
57
Chapter Nine