Perfect Competition and the Supply Curve

Chapter 15: Perfect Competition and the Supply Curve

Defining Perfect Competition

• Price-takers:

  • All market participants, both consumers and producers, are price-takers.

• Market structure characteristics:

  1. Many Producers and Many Consumers:

     • Each participant (producer/consumer) is a "drop in the bucket" regarding supply and demand dynamics.

  2. Identical Product:

     • Defined as a standardized product (also known as a commodity).

     • Consumers perceive products from different sellers as identical.

  3. Perfect Information:

     • Complete knowledge about prices, product quality, and production methods among consumers and producers.

  4. Free Entry and Exit:

     • New producers can enter an industry easily, and existing producers can easily leave.

What’s A Standardized Product?

• The issue of whether Korean kimchi producers’ claims to authenticity are valid highlights that differences in quality are based on consumer perceptions rather than inherent product qualities. Some examples are:

  • Is Japanese kimchi seen as inferior compared to the Korean original?

  • Economic interpretation: Products are considered different only if believed so by consumers.

Market Competitiveness Inquiry

• Question: Which of these markets is likely to be the MOST competitive?

  • Options:

  1. Cable television

  2. Automobiles and trucks

  3. Oil refining

  4. Farm commodities

Production And Profits

• Total Revenue (TR):

  • Defined as the equation: $TR = P imes Q$

• Profit:

  • Calculated as: $ext{Profit} = TR - TC$

Profit Maximization Example

• 
  

• Price = $72:

  • Profit maximization occurs at the quantity of trees $Q = 50$.

• 
  

• Table of Profitability for Noelle’s Farm when Market Price is $72:
  

  Quantity of Trees (Q)	Total Revenue (TR)	Total Cost (TC)	Profit (TR - TC)
  0	$0	$560	-$560
  10	$720	$1,200	-$480
  20	$1,440	$1,440	$0
  30	$2,160	$1,760	$400
  40	$2,880	$2,240	$640
  50	$3,600	$2,880	$720
  60	$4,320	$3,680	$640
  70	$5,040	$4,640	$400
  Marginal Analysis And The Profit-Maximizing Output

  • Principle of Marginal Analysis:

    • The optimal quantity of an activity is at the point where marginal benefit equals marginal cost.

  • Marginal Revenue (MR):

    • Defined as the change in total revenue generated by an additional unit of output: $MR = rac{ riangle TR}{ riangle Q}$.

    • Since the firm is a price-taker, $MR$ equals the market price: the firm can sell as much as it wants at this price; its MR curve is horizontal.

  • Demand Curve:

    • For a price-taker, it faces a perfectly elastic demand curve equivalent to its marginal revenue curve.

  • Optimal Output Rule:

    • Profit is maximized by producing at the quantity where $MR = MC$ (Marginal Cost).

  Justification for Profit Maximization

  • Why profit is maximized where $MR = MC$:

    • Producing additional units incurs extra costs and extra revenues.

    • If extra revenue from producing another unit exceeds its cost, profit increases.

    • If MR > MC, more production increases profit; if MR < MC, less production increases profit.

    • Therefore, the profit-maximizing condition for competitive firms translates to choosing output where $P = MC$.

  Graphical Representation

  • The graphical relationship between price, cost, and revenue can be depicted as follows:

    • Price, Cost of Tree Graph:

    • When Price (P) equals Marginal Cost (MC) at optimal point E, the profit-maximizing quantity is evident.
      

      

  Short-Run Costs for Noelle’s Farm

  • 
    

  • Increasing Production Dynamics:

    • Increasing production by one more unit is sensible if this leads to more marginal revenue than marginal cost.

  • 
    

  • Cost Table for Noelle's Farm:
    

    Quantity of Trees	Variable Cost (VC)	Total Cost (TC)	Marginal Cost	Marginal Revenue	Net Gain (Marginal Profit)
    0	$0	560
    10	$640	$1,200	64	72	8
    20	$880	$1,440	24	72	48
    30	$1,200	$1,760	32	72	40
    40	$1,680	$2,240	48	72	24
    50	$2,320	$2,880	64	72	8
    60	$3,120	$3,680	80	72	-8
    70	$4,080	$4,640	96	72	-24
    Pitfall of Inexact Marginal Revenue and Cost Equality

    • Scenario:

      • If there is no output level for which marginal revenue equals marginal cost, the recommendation is to produce the largest quantity for which MR > MC.

    Economic Profit Considerations

    • Definitions:

      • Economic profit incorporates both implicit cost (foregone benefits) and explicit cost (cash outlays).

      • Profit assessments yield:

      • If TR > TC: Firm is profitable.

      • If $TR = TC$: Firm breaks even.

      • If TR < TC: Firm incurs a loss.

    • Profit Expressions:

      • $Profit = TR - TC = (P - ATC) imes Q$

      • Where:

      • If P > ATC: The firm is profitable.

      • If $P = ATC$: The firm breaks even.

      • If P < ATC: The firm incurs a loss.

    Short-Run Cost and Production Analysis

    • The break-even price for a price-taking firm is the market price that results in zero profit.

    Profitability and Market Price Dynamics

    • Analysis reveals: (a) A farm is profitable if P > min ATC ext{ (e.g. $56)}; calculated profit:

      • Per unit profit: P - ATC(Q*) = $72.00 - $57.60 = 14.40

      • Total profit: $(P - ATC(Q<em>)) imes Q</em> = 50 imes 14.40 = 720$
        (b) A farm incurs a loss if P < min ATC ext{ (e.g. $56)}; calculated loss:

      • Per unit loss: P - ATC(Q*) = $40.00 - $58.67 = -18.67

      • Total loss: $(30 imes -18.67 = -560)$

    Short-Run Production Decision Insights

    • Losses Discussion:

      • Losses don’t equate to immediate shutdown due to fixed cost obligations.

      • Fixed costs are paid regardless of production decisions.

      • Since fixed costs cannot be altered in the short run, they are irrelevant to shutdown decisions.

      • Variable costs are significant in this context.

      • If market price is below minimum average variable cost, a firm should cease production.

      • If price exceeds minimum average variable cost, production should continue in the short run.

    Short-Run Individual Supply Curve Dynamics

    • A firm will produce above the minimum AC where the price intersects with their marginal cost curve, but will stop if market price drops below the shut-down price.

    • The MC curve (above shut-down price) functions as the firm’s supply curve.

    Changing Fixed Costs Discussion

    • Fixed Cost Adjustments:

      • Buying/selling equipment allows modification of fixed costs for a firm.

      • A firm aims to adjust fixed costs to minimize average total costs for targeted output levels, which might necessitate complete shutdown.

    Pitfall Discussion on Economic Profit

    • Entry Question:

      • Why enter an industry if the market price is only slightly greater than break-even?

      • Reason: Economic profit, as a key measure indicates that if the market price exceeds break-even, the firm stands to gain more than in alternative industries.

    Profitability Condition Dynamics

    • Profitability Conditions Based on ATC:

      • Result when Price (P) vs. minimum ATC:

      • P > min ATC: Firm profitable; entry in long run.

      • $P = min ATC$: Firm breaks even; stable entry/exit relation.

      • P < min ATC: Firm unprofitable; exit in long run.

    • Profitability Conditions Based on AVC Dynamics:

      • Result when Price (P) vs. minimum AVC:

      • P > min AVC: Firm produces short run.

      • $P = min AVC$: Firm indifferent to production.

      • P < min AVC: Firm halts production short run.

    Academic Questions on Firm Operating

    • Analyze conditions for Lily’s flower pot company:

      • Cost considerations (Fixed costs = $50,000):

      • 
        a. Determine break-even and shutdown prices.

      • b. Decisions for short run at price $2.

      • c. Profit-maximizing quantities and total profit at price $7.

      • d. Profit-maximizing quantities and total profit at price $20.

    Short-Run Market Equilibrium Definition

    • The short-run market equilibrium is the state where quantity supplied equals quantity demanded while the number of producers remains constant.

    Long-Run Market Equilibrium Dynamics

    • New entrants continue as long as economic profit (where P > min ATC) exists.

    • A market achieves long-run equilibrium when the supplied quantity equals the demanded quantity, given sufficient time for industry entry and exit.

    Demand Impact Analysis on Competition Dynamics

    • Demand Increase Effects:

      • Short-run vs. Long-run response: The long-run supply response is characterized by adjustments in output relative to pricing as firms enter/exit the industry.

    Comparative Analysis of Short-run and Long-run Supply Curves

    • The long-run supply curve is typically flatter than the short-run supply curve.

      • Higher prices in the long run attract new entrants, raise industry output, and subsequently lower prices.

      • A price drop in the long term leads to producer exits, reducing output and raising prices again.

    Long-Run Industry Supply Curve Characteristics

    • Long-run supply curve elasticity:

      • If costs are stable among firms, the long-run supply curve is perfectly elastic. Example: Agriculture with elastic input supply.

      • The slope is upward with limited input supply since price rises with input cost as industry expands. Example: Beachfront resort hotels.

      • The slope is downward if industries experience increasing returns to scale. Example: the technology sector with established networks and labor pools.

    Long-Run Price Elasticity of Supply Characteristics

    • Long-run Price Elasticity:

      • Generally higher than that of the short run when there is free market entry/exit regardless of the slope of the supply curve.

    Comprehensive Market Equilibrium Analysis

    • Question: What is true in the long-run market equilibrium for all firms?

      • Options:

      1. Earning zero economic profit.

      2. Producing at their break-even price.

      3. Producing the profit-maximizing quantity where $MR = MC$.

      4. All the above statements are accurate.

    Business Case Analysis: Retail Wars

    • Competitive Conditions Inquiry:

      1. Assess the retail market for electronics; review competition conditions before mobile app price checking impact.

      2. Analyze shopping apps' overall competitive impact on consumer surplus and brick-and-mortar profitability (e.g., Best Buy).

      3. Examine strategies where retailers opt for manufacturer-exclusive versions and the outlook for this trend.