A2 Economics Aims and Objectives Aim Understand perfectly competitive markets Objectives Recall the assumptions of perfectly competitive markets Explain how a perfectly competitive firm decides its output ID: 250155
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Slide1
Perfect Competition
A2 EconomicsSlide2
Aims and Objectives
Aim:
Understand perfectly competitive marketsObjectives:Re-call the assumptions of perfectly competitive markets
Explain how a perfectly competitive firm decides its output.
Analyse how profits differ in the short and long run in perfectly competitive markets.Slide3
Starter: PERFECT RECALL- Perfectly Competitive Markets - Assumptions
Many
suppliers each with an insignificant share of market
Each
firm is too small to affect price via a change in market supply –
each individual
firm is a price
taker
Identical
output produced by each firm – homogeneous products that
are perfect
substitutes for each
other
Consumers
have complete information about
prices
Transactions are costless - Buyers and sellers incur no costs in making an exchange
All firms (industry participants and new entrants) have equal access to resources (e.g. technology)
No barriers to entry & exit of firms in long run – the market is open to competition from new suppliers
No externalities in production and consumptionSlide4
Starter: PERFECT RECALL- Perfectly Competitive Markets - Assumptions
Many
suppliers each with an insignificant share of market
Each
firm is too small to affect price via a change in market supply –
each individual
firm is a price
taker
Identical
output produced by each firm – homogeneous products that
are perfect
substitutes for each
other
Consumers
have complete information about
prices
All firms (industry participants and new entrants) have equal access to resources (e.g. technology)
No barriers to entry & exit of firms in long run – the market is open to competition from new suppliers
No externalities in production and consumptionSlide5
AnswerTransactions are costless - Buyers and sellers incur no costs in making an exchangeSlide6
Starter: PERFECT RECALL- Perfectly Competitive Markets - Assumptions
Many
suppliers each with an insignificant share of market
Identical
output produced by each firm – homogeneous products that
are perfect
substitutes for each
other
Consumers
have complete information about
prices
Transactions are costless - Buyers and sellers incur no costs in making an exchange
All firms (industry participants and new entrants) have equal access to resources (e.g. technology)
No barriers to entry & exit of firms in long run – the market is open to competition from new suppliers
No externalities in production and consumptionSlide7
AnswerEach firm is too small to affect price via a change in market supply – each individual firm is a price takerSlide8
Starter: PERFECT RECALL- Perfectly Competitive Markets - Assumptions
Many
suppliers each with an insignificant share of market
Each
firm is too small to affect price via a change in market supply –
each individual
firm is a price
taker
Identical
output produced by each firm – homogeneous products that
are perfect
substitutes for each
other
Consumers
have complete information about
prices
Transactions are costless - Buyers and sellers incur no costs in making an exchange
All firms (industry participants and new entrants) have equal access to resources (e.g. technology)
No externalities in production and consumptionSlide9
AnswerNo barriers to entry & exit of firms in long run – the market is open to competition from new suppliersSlide10
Re-Cap: Price Takers
In the market price for product X reaches equilibrium at £5.
Individual firm has to accept this price.
If it sells above £5 consumers will go elsewhere.
If it sells below it will have plenty of consumers, but will not be maximising its returns.
Price of X
Quantity Demanded and Supplied
D
£5
S
Price of X
D=AR=MR=P
10
0
0
The Firm
The MarketSlide11
How Many Does a Firm Produce?
Firms wanting to profit maximise will produce where MC = MR.
Revenue & Cost of X
D=AR=MR=P
10
0
£80
Quantity Demanded and Supplied
MR=MC at 10 units.
Therefore TR = 80 x 10 = £800
MCSlide12
How Many Does a Firm Produce?
To be able to calculate profit we need to calculate total costs.
Total Costs = ATC x Output
Revenue & Cost of X
D=AR=MR=P
10
0
£80
Quantity Demanded and Supplied
£60
MC
ATC
Output of 10 units the ATC is £60
pu
Total costs = 60x10 = £600
TR – TC = £200.
As we include normal profit in costs, this £200 is supernormal or abnormal profit.Slide13
Supernormal Profit
If supernormal profit is being made, other firms will wish to enter the industry in an attempt to earn a portion of these profits.
As there are no barriers to entry they will do so until supernormal profits are eroded away!
Revenue & Cost of X
D=AR=MR=P
10
0
£80
Quantity Demanded and Supplied
£60
MC
ATCSlide14
Market Response: Supernormal Profit Eroded Away
Initial equilibrium ruling price of £80, individual firm able to make £20pu supernormal profits.
Other firms attracted by supernormal profits shift supply curve right.
Price of X
Quantity Demanded and Supplied
D
£80
S
Revenue & Cost
D=AR=MR=P
10
0
0
The Firm
The Market
MC
S1
£60
D=AR=MR=P1
8
ATC
£80
£60Slide15
Market Response: Supernormal Profit Eroded Away
Firms continue to enter until supernormal profit eroded away.
Ruling price falls as does the firms revenue curve.
To maximise profits (MC=MR) it has to reduce its output to 8 units.
Price of X
Quantity Demanded and Supplied
D
£80
S
Revenue & Cost
D=AR=MR=P
10
0
0
The Firm
The Market
MC
S1
£60
D=AR=MR=P1
8
ATC
£80
£60Slide16
Market Response: Supernormal Profit Eroded Away
Any output beyond 8 adds more to costs then to revenue.
Firm output has fallen.Due to entry of other firms, its market share has fallen too!
Price of X
Quantity Demanded and Supplied
D
£80
S
Revenue & Cost
D=AR=MR=P
10
0
0
The Firm
The Market
MC
S1
£60
D=AR=MR=P1
8
ATC
£80
£60Slide17
Market Response: Supernormal Profit Eroded Away
TR = 60 x 8 = 480
TC = 60 x 8 = 480Firm now making normal profitThis is the
long run equilibrium position
for a firm in perfect competition.
Where ATC and ATR are equal.
Therefore…..
Normal Profit = ATC = ATRSlide18
Worksheet
Questions:
Using Microsoft Excel/Microsoft Publisher construct a diagram showing the industry position and, using the equilibrium prices and information from the table above construct the diagram of the firm.
At a price of £60 what quantity would the firm have been producing?
What was its level of supernormal profits or losses?
Explain why a price of £40 is sufficient to keep the firm in the industry.