Ch 12 Perfect Competition

Perfect Competition and the Supply Curve

Introduction

• The chapter focuses on perfect competition and the concept of the supply curve, essential for understanding market dynamics.

Learning Objectives

• Understand what perfect competition is and its significance as an economic benchmark.

• Identify the factors that create a perfectly competitive market.

• Determine the profit-maximizing output level in a perfectly competitive industry.

• Analyze profitability and conditions under which firms are profitable or unprofitable. -Understand the distinction between short-run and long-run behaviors of firms.

• Compare the short-run and long-run industry supply curves.

Defining Perfect Competition

• Price Takers: All market participants, consumers, and producers must accept the market price as given.

• Market Share: Each producer has a small share within the market; their output does not significantly affect prices.

• Standardized Products: Consumers see the products as equivalent, leading to homogeneity in offerings.

Free Entry and Exit

• Perfectly competitive markets allow for easy entry and exit of firms, maintaining market fluidity.

Practice Question 1

• Which market is most competitive? (Answer: Farm commodities)

Production and Profits

Revenue and Profit Calculation

• Total Revenue (TR): Calculated as TR = Price (P) × Quantity Sold (Q).

• Profit: Determined by Profit = Total Revenue (TR) - Total Cost (TC).

Profit Maximization Example

• When the market price is $72, profit peak occurs at Q = 50. Illustrated through a table showing revenue and costs at varying quantities.

Marginal Analysis and Output

Principles of Marginal Analysis

• Optimal Output Rule: Profit is maximized where marginal revenue (MR) equals marginal cost (MC).

• Marginal Revenue: For price-taking firms, MR equals market price, depicted as a horizontal line.

Decision-Making Process

• If MR > MC, increase production; if MR < MC, reduce production. Profit maximization occurs where P = MC.

Profitability Conditions

Economic Profit

• Evaluated based on TR and TC, including both explicit and implicit costs.

• Conditions: TR > TC (profit), TR = TC (break-even), TR < TC (loss).

Short-Run Production Decision

• Fixed costs remain in the short run; variable costs are critical for production decisions.

• Shut-down Criteria: A firm should cease production if market price falls below the minimum average variable cost (AVC).

Conclusion: Analyzing Profitability

Market Price Impact

• Break-even Price: If market price equals the minimum average total cost (ATC), firms earn zero profit. Variations in price relative to ATC inform production decisions:

  • P > min ATC: Profitable outcome.

  • P = min ATC: Break-even scenario.

  • P < min ATC: Firms exit market long term.

Short-Run vs Long-Run Supply Curve

Industry Dynamics

• Short-Run Supply Curve: Depicts output based on a fixed number of producers and current market prices.

• Long-Run Supply Curve: Adjusts as firms enter or exit the market based on profitability, making it more elastic and responsive to market changes.

Pricing and Cost Analysis in Long Run

• Long-run curves adjust in response to input costs; they may slope up or down based on returns to scale and competition metrics.

Conclusion on Economic Profit

• Economic profit serves as an indicator for industry entry; even slight profits encourage new competitors, impacting overall market stability and price structures.

Practice Question 5

• Outcome in long-run equilibrium with identical firms: All firms earn zero economic profit and produce at the break-even price.