Micro Chapter 12 - Perfect Competition

Profit Maximisation

producing output at a minimum cost

Economic Profit

total revenue - total cost, takes account of explicit and opportunity cost

Accounting profit

no implicit costs included, no opportunity cost

Normal Profit

Opportunity cost of resources owned by the firm.

marginal revenue

slope of the revenue curve, the change in revenue that occurs when the sale of output changes by 1 unit

Marginal cost

slope of the total cost curve

profit maximisation point

when slope of profit curve is 0, when MR = MC or when slopes of revenue and costs are equal, when the gap between the two curves is greatest

Profit Equation

(P-ATC)Q where the sign determines loss or gain, PQ -TC = Total Revenue - Total Cost = TR(q) - TC(q), need to check second derivative is < 0 to show max, not min

4 conditions for Perfect Competition

Firms sell a standardised product, firms are price takers, free entry and exit with perfectly mobile factors of production in the long run, everyone has perfect information

1. Firms sell a standardised product

easily substituted

2. Firms are price takers

individual firms treat the market price as a given, no firm individually has the power to change or influence the price, price not affected by how much output produced

3. Free entry and exit and mobile factors of production

if firms perceive profitable opportunity, they can enter easily and on the other hand, can leave quickly if not as profitable. no resource is perfectly mobile eg labour, however firms can move to the workers

4. Perfect Information

firms have no reason to leave if it has no notion as to how profitable an industry is, those that can acquire the most information will benefit

Maximising economic profit rule

provided P0 is larger than minimum AVC, produce an output where MR = MC = P

Shutdown Condition

1. TR < TVC , 2. TR/Q < TVC/Q which is AR < AVC which is equivalent to P < AVC as P = AR in perfectly competitive market

Demand curve for individual firm

sales have no effect on market price, horizontal line, perfectly elastic demand, perfect substitutes available, price line = marginal revenue line = average revenue line

Demand Curve for whole market

shows amount of goods consumers purchase at different prices, downward sloping

Supply Curve Market

horizontally sum each individual supply curve to find the total industry

Zero economic profit when…

total revenue = total cost including opportunity cost of resources, this is when price = ATC which is the breakeven point, the lowest price at which the firm doesn't suffer a loss in the short run

Short Run equilibrium

P > ATC -> positive economic profit. AVC < P < ATC -> loss but still produces as the loss is less than TFC

Allocative Efficiency

a condition in which all possible gains from exchange are realised, fully exploit possibilities for mutual gains through exchange

Pareto Efficiency

an outcome where it is not possible to make some person better off without harming another person

Short Run producer surplus

larger than economic profit as the firm would lose more than the economic profit if it didn't participate in the market

Producer Surplus

the monetary amount by which a firm benefits by selling an output, how much better off a firm is as a result of having supplied its profit-maximising level of output, also the supply curve up to the price line

Long Run Producer Surplus

all costs are variable so producer surplus would = economic profit

aggregate producer surplus

add producer surplus for each firm that participates

total benefits from exchange in the market place

sum of producer and consumer surplus

Adjustments in the long run

the aim is still to earn the highest economic profit however they can now; 1. change fixed inputs which will change the SMC and SRS curve and 2. they can also leave or enter the industry which changes the industry supply curve

As new firms enter, the industry supply curve…

shifts to the right

Average cost curves will now

have U-shaped LAC, falling prices will continue until both 1. P= minimum LAC curve and 2. all firms moved to capital stock size that gives rise to short run ATC curve which is tangent to LAC curve at its minimum

Long Run Industry Supply curve types LAC

U-shaped - perfect competition, Horizontal - no change, Downward sloping - natural monopoly, Upward sloping - large number of small firms

Changing input price on long run supply

pecuniary diseconomy

pecuniary diseconomy

a rise in production cost that occurs when an expansion of industry output causes a rise in the prices of inputs

Increasing Cost Industries

competitive industries in which rising input prices lead to upward sloping supply curves

Pecuniary economies

if inputs are manufactured using technologies in economies of scale, prices of inputs may fall significantly with expanding industry output

Decreasing cost industries

competitive industries in which falling input prices leads to downward sloping supply curves

Price elasticity of supply

% change in quantity that occurs in response to a 1% change in product price

Price elasticity of supply equation

P/Q x 1/slope or ^Q/^P x P/Q

due to diminishing law of returns in short run

short run competitive industry supply will be upward sloping and elasticity of supply will be positive

pecuniary economy supply curve

downward sloping

pecuniary diseconomy supply curve

upward sloping

Applying the Competitive Model

when important long run properties don't always apply eg. government puts in legal barriers to entry

Cost saving innovation

PCM have no control over goods however they have control over cost to produce, cost saving production methods can increase market share and increase profit aswell as reduce labour costs

Who Benefits from Innovation

PC firms, firms to keep survival in the industry, short run profit may encourage more firms to enter the market

In long run equilibrium competitive firm operates

at the minimum point of its short run average cost curve

a main reason for scepticism around the profit-maximisation assumption is the existence of

unqualified managers

threat firms come under from a possible outsider takeover is an important force supporting…

profit-maximising behaviour

evolutionary argument

long run tendency for profit-maximisation behaviour will dominate so will grow faster than rival firms and less probability of bankrupt

the portion of the MC curve that lies above the minimum AVC is the

short run supply curve

in a PCM, it will be optimal for a firm to continue production even when making a loss if

the price of output exceeds the average variable cost

in the short run, producer surplus often differs from economic profit due to

fixed costs

the difference between total revenue and total variable cost or the area between the market price and the marginal cost curve are two ways of depicting

producer surplus

Controlled economy

an economy where resources are centrally coordinated

why might competitive markets not always lead to the best possible outcome

depends on the initial wealth distribution

system of price support

government attempts to try to save small owned firms etc. from decreasing prices by setting a price that prevents these firms form going bankrupt and buying all output that private buyers do not buy

short run and long run goal respectively of cost saving innovation

earning profit and surviving in the industry