Microeconomics3e-Ch08

Chapter 8: Perfect Competition

8.1 Perfect Competition and Why It Matters

• Market Structure: Refers to the characteristics of an industry, including the number of sellers, ease of entry, and types of products offered.

• Perfect Competition: A market structure where many firms sell identical products. Key criteria include:

  • Many firms producing identical products.

  • Many buyers and sellers present in the market.

  • Complete information is available to buyers and sellers for rational decision-making.

  • Freedom of entry and exit for firms.

• Price Taker: A firm that must accept the market price as given, which is typical in perfectly competitive markets.

8.2 How Perfectly Competitive Firms Make Output Decisions

• The primary decision for a perfectly competitive firm is determining the optimal quantity to produce.

• Firms must accept the market price, which is influenced by demand and supply.

• The goal is to maximize profit, achieved when the difference between total revenue and total cost is maximized.

8.3 Understanding Revenue and Cost at the Raspberry Farm

• Total Revenue (TR): Increases linearly with output; the slope equals the product's price.

• Total Cost (TC): Increases with output but reflects diminishing marginal returns, curving more steeply at higher outputs.

• Profit maximization occurs where the difference between TR and TC is greatest.

8.4 Decision-Making with Marginal Metrics

• Marginal Revenue (MR): Additional revenue from selling one more unit.

• Marginal Cost (MC): Additional cost incurred from producing one more unit.

• Profit maximization is achieved at the output level where MR equals MC.

8.5 Price Determination in the Raspberry Market

• The equilibrium price ($4.00) is where market supply meets demand, with 80 units supplied per farm if there are 10 farms.

8.6 Individual Farmer's Revenue and Cost

• In perfect competition, MR is a horizontal line at the market price; the MC curve may initially slope down before increasing due to diminishing returns.

8.7 Profit and Loss Analysis

• Decisions based on the relationship between price and average total cost (ATC) determine if a firm makes a profit, breaks even, or incurs a loss.

• If price intersects MC above the ATC, the firm earns a profit; at the ATC, it breaks even; below the ATC, it incurs a loss.

8.8 Understanding the Shutdown Point

• Shutdown Point: The price level where the firm is indifferent to producing or shutting down, occurring at the minimum average variable cost (AVC).

• If the price is below the minimum AVC, the firm should shut down.

8.9 Short-Run Outcomes for Firms

• Three Zones of MC: The MC curve can be divided based on its intersection with AC curves, indicating different profit scenarios.

  • If price exceeds break-even, firms earn profits.

  • At break-even, firms earn zero profits.

  • If price is between the shutdown point and break-even, firms will continue operating but incur losses.

8.10 Long-Run Entry and Exit Decisions

• New firms enter the market when profits increase, leading to long-run equilibrium where economic profits are zero.

• Firms will adjust production in response to sustained patterns of profit or loss.

8.11 Types of Industries and Cost Variability

• Constant-Cost Industry: Production costs remain stable as demand increases.

• Increasing-Cost Industry: Production costs rise as demand increases.

• Decreasing-Cost Industry: Production costs decline as demand increases.

8.12 Efficiency in Perfectly Competitive Markets

• Profit-maximizing behavior leads to both productive and allocative efficiency, where:

  • Productive Efficiency: Production occurs at the lowest average cost in the long-run.

  • Allocative Efficiency: Resources are allocated based on societal preferences, where price equals marginal cost (P=MC).

8.13 Real-World Comparison to Perfect Competition

• Perfect competition serves as a theoretical benchmark; real-world markets experience various complexities including:

  • Environmental pollution

  • Technological advancements

  • Poverty and market imperfections

  • Government intervention and discriminatory practices in labor markets.