12 Competition Competition What is perfect competition How are price and output determined in a competitive industry Why do firms enter and leave an industry How do changes in demand and technology affect an industry ID: 417564
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Slide1
CHAPTER 12CompetitionSlide2
CompetitionWhat is perfect competition?How are price and output determined in a competitive industry?Why do firms enter and leave an industry?How do changes in demand and technology affect an industry?Why is perfect competition economically efficient?Slide3
Perfect CompetitionPerfect competition arises when:There are many firms, each selling an identical product.There are many buyers.There are no restrictions on entry
into the industry.
Firms in the industry have
no advantage over potential new entrants
.
Firms and buyers are
completely informed about other firms’ prices
.Slide4
The Firm Has No Control Over the Price It ChargesSince each firm produces a small fraction of total industry output and the products are identical, no firm has any control over price.Firms are price takers in perfectly competitive markets. A price taker is a firm that cannot influence the price of a good or service.Slide5
Elasticity of Industryand Firm DemandA price taker firm faces a demand curve that is perfectly elastic (horizontal) because the product from firm A is a perfect substitute for the product from firm B.However, the market demand curve will still slope downward; elasticity will be positive, but not infinite.Slide6
Competition inthe Real WorldIn reality, there are no markets that are absolutely perfectly competitive.However, competition in some industries is so fierce that the model of perfect competition predicts extremely well how firms will behave.Examples are computers, soft drinks, TVs, DVD players, potato chips, etc.Slide7
Economic Profit and Revenue
Total revenue (TR)
Value of a firm’s sales
TR = P
Q
Marginal revenue
(MR)
Change in total revenue resulting from a one-unit increase in quantity sold.
MR = TR/ Q
Average revenue (AR)
Total revenue divided by the quantity sold — revenue per unit sold.
AR = TR/Q = PxQ/Q = P
In perfect competition, Price = MR = ARSlide8
Economic Profit and Revenue
Suppose Cindy sells her sweaters in a perfectly competitive market.
What are Cindy’s TR, MR, and AR?Slide9
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25
9 25
10 25 Slide10
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200
9 25
10 25 Slide11
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200
9 25 225
10 25 Slide12
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200
9 25 225
10 25 250 Slide13
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 -
9 25 225
10 25 250 Slide14
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 -
9 25 225 25
10 25 250 Slide15
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 -
9 25 225 25
10 25 250 25 Slide16
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 - 25
9 25 225 25
10 25 250 25 Slide17
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 - 25
9 25 225 25 25
10 25 250 25 Slide18
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal Average
sold (P) Total revenue revenue
(Q)
(dollars
revenue
AR = TR/Q
(sweaters per
TR = P ´ Q
(dollars per (dollars
per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 - 25
9 25 225 25 25
10 25 250 25 25Slide19
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousands
of sweaters per day)
Quantity (sweaters per day)
Quantity (sweaters per day)
Price (dollars per sweater)
Price (dollars per sweater)
Total revenue (dollar per day)
0 9 20 0 10 20 0 9 20
25
50
25
225
50
Sweater
Industry
Cindy’s demand,
average revenue, and
marginal revenue
Cindy’s total
revenueSlide20
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousands
of sweaters per day)
Quantity (sweaters per day)
Quantity (sweaters per day)
Price (dollars per sweater)
Price (dollars per sweater)
Total revenue (dollar per day)
0 9 20 0 10 20 0 9 20
25
50
25
225
50
S
D
Sweater IndustrySlide21
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousands
of sweaters per day)
Quantity (sweaters per day)
Quantity (sweaters per day)
Price (dollars per sweater)
Price (dollars per sweater)
Total revenue (dollar per day)
0 9 20 0 10 20 0 9 20
25
50
25
225
50
S
D
AR=
MR
Sweater Industry
Cindy’s demand,
average revenue, and
marginal revenue
Cindy’s
demand
curveSlide22
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousands
of sweaters per day)
Quantity (sweaters per day)
Quantity (sweaters per day)
Price (dollars per sweater)
Price (dollars per sweater)
Total revenue (dollar per day)
0 9 20 0 10 20 0 9 20
25
50
25
225
50
S
D
AR=
MR
TR
a
Sweater
Industry
Cindy’s demand,
average revenue, and
marginal revenue
Cindy’s total
revenue
Cindy’s
demand
curveSlide23
Economic Profit and Revenue
The firm’s goal is to
maximize economic profit
.
Total cost is the opportunity cost — including
normal profit
.Slide24
The Firm’s Decisions in
Perfect Competition
A firm’s task is to make the maximum economic profit possible, given the constraints it faces.
In order to do so, the firm must make two decisions in the short-run, and two in the long-run.Slide25
The Firm’s Decisions in
Perfect Competition
Short-run
A time frame in which each firm has a given plant and the number of firms in the industry is fixed
Long run
A time frame in which each firm can change the size of its plant and decide whether to leave or stay in the industry.Slide26
The Firm’s Decisions in
Perfect Competition
In the short-run, the firm must decide:
Whether to produce or to shut down.
If the decision is to produce, what quantity to produce.
Price is not a decision because firm is a price taker.Slide27
The Firm’s Decisions in
Perfect Competition
In the long-run, the firm must decide:
Whether to increase of decrease its plant size
Whether to stay in the industry or leave it
We will first address the short-run.Slide28
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22
1 25 45
2 50 66
3 75 85
4 100 100
5 125 114
6 150 126
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide29
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45
2 50 66
3 75 85
4 100 100
5 125 114
6 150 126
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide30
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66
3 75 85
4 100 100
5 125 114
6 150 126
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide31
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85
4 100 100
5 125 114
6 150 126
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide32
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100
5 125 114
6 150 126
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide33
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114
6 150 126
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide34
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide35
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide36
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide37
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183
10 250 210
11 275 245
12 300 300
13 325 360
Slide38
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183
42
10 250 210
11 275 245
12 300 300
13 325 360
Slide39
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183
42
10 250 210 40
11 275 245
12 300 300
13 325 360
Slide40
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183
42
10 250 210 40
11 275 245 30
12 300 300
13 325 360
Slide41
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183
42
10 250 210 40
11 275 245 30
12 300 300 0
13 325 360
Slide42
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183
42
10 250 210 40
11 275 245 30
12 300 300 0
13 325 360 -35
Slide43
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(sweaters
(TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
12 300 300 0
13 325 360 -35
Slide44
Total Revenue, Total Cost,
and Economic Profit
Quantity (sweaters per day)
Total revenue & total cost
(dollars per day)
0 4 9 12
100
300
183
225
Revenue
and CostSlide45
Total Revenue, Total Cost,
and Economic Profit
Quantity (sweaters per day)
Total revenue & total cost
(dollars per day)
0 4 9 12
100
300
183
TR
225
Revenue
and CostSlide46
Total Revenue, Total Cost,
and Economic Profit
Quantity (sweaters per day)
Total revenue & total cost
(dollars per day)
0 4 9 12
100
300
183
TR
TC
225
Revenue
and CostSlide47
Total Revenue, Total Cost,
and Economic Profit
Quantity (sweaters per day)
Total revenue & total cost
(dollars per day)
0 4
9
12
100
300
183
225
TR
TC
Economic
loss
Economic
profit =
TR - TC
Revenue
and CostSlide48
Total Revenue, Total Cost,
and Economic Profit
4
9
12
-
20
0
-
40
42
20
Quantity
(sweaters
per day)
Profit/
loss
Profit/loss
(dollars per day)
Economic
profit/lossSlide49
Total Revenue, Total Cost,
and Economic Profit
Quantity
(sweaters
per day)
4
9
12
-
20
0
-
40
42
20
Profit
maximizing
quantity
Profit/
loss
Economic
profit
Economic
loss
Profit/loss
(dollars per day)
Economic
profit/lossSlide50
Total Revenue, Total Cost,
and Economic Profit
Quantity
(sweaters
per day)
4
9
12
-
20
0
-
40
42
20
Profit
maximizing
quantity
Profit/
loss
Profit/loss
(dollars per day)
MR>MC
MR<MC
MR=MCSlide51
Break-even OutputAn output at which total cost equals total revenue is called a break-even point.Even though economic profit is zero at break-even output, the firm still earns a normal profit.Remember, normal profit is part of total (opportunity) cost.Slide52
Total Revenue, Total Cost,
and Economic Profit
Quantity (sweaters per day)
Total revenue & total cost
(dollars per day)
0 4
9
12
100
300
183
225
TR
TC
Breakeven PointsSlide53
Total Revenue, Total Cost,
and Economic Profit
Quantity
(sweaters
per day)
4
9
12
-
20
0
-
40
42
20
Profit
maximizing
quantity
Profit/loss
(dollars per day)
Breakeven Point
Breakeven Point
Profit/
lossSlide54
Marginal Analysis
Using
marginal analysis
, a comparison is made between a units marginal revenue and marginal cost.Slide55
Marginal Analysis
If MR > MC, the extra revenue from selling one more unit exceeds the extra cost.
The firm should increase output to increase profit
If MR < MC, the extra revenue from selling one more unit is less than the extra cost.
The firm should decrease output to increase profit
If MR = MC economic profit is maximized.Slide56
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
-Slide57
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
-
25Slide58
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
19
-
25Slide59
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
19
-
25
25Slide60
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
19
23
-
25
25Slide61
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
19
23
-
25
25
25Slide62
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
19
23
27
-
25
25
25Slide63
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
19
23
27
-
25
25
25
25Slide64
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
-
19
23
27
35
-
25
25
25
25Slide65
Profit-Maximizing Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (
dollars per
cost
(dollars per
profit
(sweaters
(TR)
additional
(TC)
additional
(TR – TC)
per day) (dollars) sweater) (dollars sweater) (dollars)
7 175 141 34
8 200 160 40
9 225
183
42
10 250 210 40
11 275 245 30
-
19
23
27
35
-
25
25
25
25Slide66
Profit-Maximizing Output
Quantity
(sweaters per day)
8 9 10
10
20
30
Marginal revenue & marginal cost
(dollars per day)
25Slide67
Profit-Maximizing Output
Quantity
(sweaters per day)
8 9 10
10
20
30
Marginal revenue & marginal cost
(dollars per day)
MR = AR = P
25Slide68
Profit-Maximizing Output
Quantity
(sweaters per day)
8 9 10
10
20
30
Marginal revenue & marginal cost
(dollars per day)
MR = AR = P
25
MCSlide69
Profit-Maximizing Output
Quantity
(sweaters per day)
8 9 10
10
20
30
Marginal revenue & marginal cost
(dollars per day)
MR = AR = P
25
MC
Profit-
maximization
point
Loss from
10th sweater
Profit from
9th sweaterSlide70
Economic Profitin the Short RunMaximizing economic profit does not guarantee that profits will be positive.Economic profit can be positive, negative or zero.To calculate total profit, we must subtract total cost from total revenue.Slide71
Price, Average Total Cost, and ProfitPrice is total revenue per unit, or average revenue (P=AR=TR/Q)Average total cost is total cost per unit (ATC=TC/Q).Profit = TR - TCProfit per unit=(TR-TC)/Q=TR/Q-TC/Q = (P - ATC) That means we can calculate total profit as (P - ATC)xQ.Slide72
Profits and Losses
in the Short-Run
As we indicated, at short-run equilibrium firms may:
Earn a profit
Break even
Incur an economic loss.Slide73
Profits and Losses
in the Short-Run
If price equals average total cost (P=ATC), a firm breaks even.
If price exceeds average total cost (P>ATC), a firm makes an economic profit.
If price is less than average total cost (P<ATC), a firm incurs an economic loss.Slide74
Quantity
(millions of chips per year)
Price
(dollars per chip)
15
.
00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
8 10
30.00
MC
ATC
Possible
Outcome One
P=ATC
Slide75
Quantity
(millions of chips per year)
Price
(dollars per chip)
15
.
00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
8
10
30.00
AR = MR = P
MC
ATC
Break-even
point
Possible
Outcome One
P=ATC
Profits=(P-ATC)xQ
=(20-20)x8 = 0Slide76
Quantity
(millions of chips per year)
Price
(dollars per chip)
15
.
00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
8 10
30.00
MC
ATC
Possible
Outcome Two
P>ATCSlide77
Quantity
(millions of chips per year)
Price
(dollars per chip)
15
.
00
20.33
25.00
Three Possible Profit Outcomes in the Short-Run
9
10
30.00
AR = MR = P
MC
ATC
Possible
Outcome Two
P>ATC
Profits
=(P-ATC)xQ
=(25-20.33)x9
=4.67x9=42Slide78
Quantity
(millions of chips per year)
Price
(dollars per chip)
15
.
00
20.33
25.00
Three Possible Profit Outcomes in the Short-Run
9
10
30.00
AR = MR = P
MC
ATC
Possible
Outcome Two
P>ATC
Profits
=(P-ATC)xQ
=(25-20.33)x9
=4.67x9=42
Economic ProfitSlide79
Quantity
(millions of chips per year)
Price
(dollars per chip)
15
.
00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
9 10
30.00
MC
ATC
Possible
Outcome Three
P<ATCSlide80
Quantity
(millions of chips per year)
Price
(dollars per chip)
17
.
00
20.14
25.00
Three Possible Profit Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Three
P<ATC
AR = MR = P
7
10
Profits
=(P-ATC)xQ
=(17-20.14)x7
=-22Slide81
Quantity
(millions of chips per year)
Price
(dollars per chip)
17
.
00
20.14
25.00
Three Possible Profit Outcomes in the Short-Run
30.00
MC
ATC
Possible
Outcome Three
P<ATC
AR = MR = P
7
10
Profits
=(P-ATC)xQ
=(17-20.14)x7
=-22
Economic LossSlide82
Three Possible Profit Outcomes in the Short-runSlide83
The Firm’s Short-Run
Supply Curve
Fixed costs must be paid in the short-run.
Variable-costs can be avoided by laying off workers and shutting down.
Firms
shut down
if price falls below the
minimum of average variable cost.Slide84
A Firm’s Supply Curve
Quantity
(sweaters per day)
7 9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)Slide85
A Firm’s Supply Curve
Quantity
(sweaters per day)
7 9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
AVC
ATCSlide86
A Firm’s Supply Curve
Quantity
(sweaters per day)
7 9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
MC
AVC
ATCSlide87
A Firm’s Supply Curve
Quantity
(sweaters per day)
7 9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
MC
MR
1
=P
1
=25
AVCSlide88
A Firm’s Supply Curve
Quantity
(sweaters per day)
7 9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
MC
MR
2
=P
2
=31
AVCSlide89
A Firm’s Supply Curve
Quantity
(sweaters per day)
7
9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
MC
MR
0
=P
0
=17
AVC
s
Shutdown
pointSlide90
A Firm’s Supply Curve
Quantity
(sweaters per day)
7
9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
MC = Supply
AVC
s
MR
1
=P
1
=25
MR
2
=P
2
=31
MR
0
=P
0
=17Slide91
A Firm’s Supply Curve
Quantity
(sweaters per day)
7
9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
S = MC
s
AVCSlide92
A Firm’s Supply Curve
Quantity
(sweaters per day)
7
9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
S = MC
s
AVCSlide93
A Firm’s Supply Curve
Quantity
(sweaters per day)
7
9 10
17
25
31
Marginal revenue & marginal cost
(dollars per day)
S = MC
sSlide94
The Firm’s Short-Run Supply CurveA perfectly competitive firm’s short-run supply curve shows how its profit-maximizing output varies as market price changes.Since price must equal marginal cost, the marginal cost curve is also the supply curve.However, only the portion of the marginal cost curve above the minimum average variable cost curve is relevant.Slide95
Temporary Plant ShutdownA firm cannot avoid incurring its fixed costs but it can avoid variable costs. A firm that shuts down and produces no output incurs a loss equal to its total fixed cost.A firm’s shutdown point is the level of output and price where the firm is just covering its total variable cost.In other words, if its losses are bigger than its fixed costs, the firm will shut down.Slide96
Production DecisionsWhen price is below the minimum point of the AVC curve, the firm will shut down and supply zero output.When price is above the lowest point of the AVC curve, the firm will produce the level of output where price equals marginal cost.The short-run supply curve is therefore the MC curve above the AVC curve.Slide97
Output, Price, and Profitin the Long RunIn short-run equilibrium, a firm might make an economic profit, incur an economic loss, or break even (make a normal profit). Only one of these situations is a long-run equilibrium. In the long run either the number of firms in an industry changes or firms change the scale of their plants.Slide98
Economic Profit and Economic Loss as Signals If an industry is earning above normal profits (positive economic profits), firms will enter the industry and begin producing output.This will shift the industry supply curve out, lowering price and profit.Slide99
Economic Loss as a SignalIf an industry is earning below normal profits (negative economic profits), some of the weaker firms will leave the industry.This shifts the industry supply curve in, raising price and profit.Slide100
Long-Run Adjustments
Forces in a competitive industry ensure only one of these situations is possible in the long-run.
Competitive industries adjust in two ways:
Entry and exit
Changes in plant sizeSlide101
Entry and Exit
The prospect of persistent profit or loss causes firms to enter or exit an industry.
If firms are making economic profits, other firms enter the industry.
If firms are making economic losses, some of the existing firms exit the industry.Slide102
Entry and Exit
This entry and exit of firms influence price, quantity, and economic profit.
Let’s investigate the effects of firms entering or exiting an industry
.Slide103
S
1
Entry
Quantity
(thousands of sweaters per day)
6 7 8 9 10
Price (dollars per sweater)
D
1
23
17
20Slide104
Entry
Quantity
(thousands of sweaters per day)
6 7 8 9 10
Price (dollars per sweater)
S
1
S
0
23
17
20
D
1Slide105
Exit
Quantity
(thousands of sweaters per day)
6 7 8 9 10
Price (dollars per sweater)
D
1
23
17
20
S
2Slide106
Exit
Quantity
(thousands of sweaters per day)
6 7 8
9
10
Price (dollars per sweater)
S
0
23
17
20
D
1
S
2Slide107
Entry and Exit
Quantity
(thousands of sweaters per day)
6 7 8 9 10
Price (dollars per sweater)
S
0
23
17
20
D
1
S
2
S
1Slide108
Entry and Exit
Important Points
As new firms enter an industry, the price falls and the economic profit of each existing firm decreases.
As firms leave an industry, the price rises and the economic loss of each remaining firm decreases.Slide109
Long-Run Equilibrium
Long-run equilibrium occurs in a competitive industry when firms are earning normal profit and economic profit is zero.
Economic profits draw in firms and cause existing firms to expand.
Economic losses cause firms to leave and cause existing firms to scale back.Slide110
Long-Run Equilibrium
So in long-run equilibrium in a competitive industry, firms neither enter nor exit the industry and firms neither expand their scale of operation nor downsize.Slide111
Long-Run EquilibriumIn long-run equilibrium, firms will be earning only a normal profit. Economic profits will be zero.Firms will neither enter nor exit the industry.In long run equilibrium, P=MC and P=ATC. Thus, P=MC=ATC.Because MC=ATC, ATC must be at its minimum.Slide112
Changing Tastes and
Advancing Technology
What happens in a competitive
industry when a permanent
change in demand occurs?Slide113
A Decrease in Demand
Quantity
Price
0
Quantity
Price and Cost
Industry
FirmSlide114
A Decrease in Demand
Quantity
Price
0
P
0
Quantity
Price and Cost
P
0
q
0
D
0
MR
0
S
0
MC
ATC
Industry
Firm
Q
0Slide115
A Decrease in Demand
Quantity
Price
0
P
0
Quantity
Price and Cost
P
0
q
0
D
0
MR
0
S
0
MC
ATC
Industry
Firm
D
1
P
1
MR
1
q
1
Q
0
Q
1
P
1Slide116
A Decrease in Demand
Quantity
Price
0
Quantity
Price and Cost
S
0
MC
ATC
Industry
Firm
D
1
P
1
MR
1
q
1
Q
1
P
1Slide117
A Decrease in Demand
Quantity
Price
0
P
0
Quantity
Price and Cost
P
0
q
0
MR
0
S
0
MC
ATC
Industry
Firm
D
1
P
1
MR
1
q
1
Q
1
S
1
Q
2
P
1Slide118
A Decrease in Demand
Quantity
Price
0
P
0
Quantity
Price and Cost
P
0
q
0
MR
0
S
0
MC
ATC
Industry
Firm
D
1
MR
1
S
1
Q
2Slide119
A Decrease in Demand
Quantity
Price
0
P
0
Quantity
Price and Cost
P
0
q
0
D
0
MR
0
S
0
MC
ATC
Industry
Firm
D
1
P
1
MR
1
q
1
Q
0
Q
1
S
1
Q
2
Summary
P
1Slide120
Changing Tastes and
Advancing Technology
Technological change
New technology allows firms to produce at lower costs.
This causes their cost curves to shift downward.
Firms adopting the new technology make an economic profit.
This draws in new technology firms
Old technology firms disappear, the price falls, and the quantity produced increases.Slide121
Changing Tastes and Advancing TechnologyA competitive industry is rarely in a long-run equilibrium.What happens in a competitive industry when there is a permanent increase or decrease in the demand for its product?What happens in a competitive industry when technological change lowers its production costs?Slide122
A Permanent Changein DemandA permanent decrease in demand will cause the short-run equilibrium price and quantity to fall.In the long run, firms will leave the industry (because economic profits are negative), raising price enough to restore a normal level of profit.The difference is the number of firms in the industry.Slide123
A Permanent Increasein DemandThe increase in demand causes industry price and profits to rise.Firms enter the industry, increasing market supply and eventually lowering price to its original level.However there are now more firms in the industry.Slide124
Technological ChangeTechnological improvements lower average cost of production.Most technological improvements cannot be implemented without investment in new plant and equipment.This means it takes time for a technological advance to spread through an industry.Slide125
Technological Change and Equilibrium Price A technological improvement that affects all firms will shift the industry supply curve down and to the right.Firms now earn economic profits and new firms enter the industry.This this drives down equilibrium price and raises industry output.Slide126
Technological Change and Equilibrium ProfitImplementing a technological improvement causes the marginal cost curve for each firm to shift down and to the right.Economic profits are not affected in the long run.The firms that survive in the long run are those that adopted the new technology early.