ECON 0100 Lecture 6: Lecture 6
What do we mean by Perfect Competition?
In a perfectly competitive market, all consumers and all producers are
price takers.
This means that no single individual or firm can affect the price.
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Conditions we need for perfect competition:
Many buyers and sellers
This guarantees that no individual buyer or seller has large
market share.
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Standardized Product (i.e. commodity)
So consumers regard products as same regardless of
producer
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Free Entry & Exit
So nothing preventing entry (no patents) and no additional
exit costs.
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Marginal Revenue for a Perfectly Competitive Firm
Recall: Marginal Revenue (MR) is the ΔTR/ΔQ
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The perfectly competitive firms are price takers.
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These firms receive the market price regardless of how much they sell.
As a result, the marginal revenue for a perfectly competitive firm
equals price.
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Thus, perfectly competitive firms have constant MR
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Decision Making for a Perfectly Competitive Curve
Firm's Decision: Select quantity produced (q) to maximize profit (π)
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Notice, that this is a "how much" type of decision, so we should use
marginal analysis to find the optimal quantity produced.
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Remember the profit maximizing rule!
Optimal quantity is the largest quantity such that MR ≥ MC
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Using Marginal Analysis to Find Profit-Maximizing Quantity
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Profit for the Perfectly Competitive Firm
Recall:
Profit = TR - TC
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TR = P * Q
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ATC = TC/q --> TC = ATC * q
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A firm will face a loss when TR < TC at q*.
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A firm will break even (produce 0 profit) when P = ATCmin at q*.
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Shut Down in the Short Run
Notice that in the previous examples, a firm always produced positive
amount.
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If a firm is earning negative economic profit and shut down (produce
nothing), will it stop incurring loss?
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Answer: not necessarily in the short run.
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EXAMPLE
Bob has a wheat farm producing the profit maximizing quantity of
10 bushels of wheat. The cost of land is $100. In addition, he
should spend $5 for other inputs he needs to produce one bushel.
If wheat sells for $6 a bushel, what is Bob's economic profit?
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Should Bob shut down in the short run? Why?
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If wheat sells for $4 a bushel, what is Bob's economic profit?
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Should Bob shut down in the short run? Why?
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Main Takeaway
At the profit maximizing quantity, so long as the total revenue a
firm is able to make from selling its goods is greater in incurs in
variable costs, it is better for the firm to continue operating in the
short run. If the total revenue is less than the firm's variable costs,
it is better for the firm to shut down in the short run.
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Shut down if TR < VC
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Shut down if P < AVC
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Example When the Firm SHOULD Shut Down in the Short Run
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The Short Run Individual Supply Curve
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The Short Run Industry Supply Curve
When considering the short run industry supply curve, the number of
producers in the market is FIXES
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Market Changes & Transitioning to the Long Run
There are two conditions for the Long Run equilibrium:
Quantity Supplied = Quantity Demanded
No shortage or surplus
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Nobody else wants to enter or exit the market.
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In the Long Run, a perfectly competitive firm's profit is always 0.
If π > 0, new firms ENTER the market and price DECREASES.
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If π < 0, some firms EXIT the market and price INCREASES.
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Example when firm has loss in the short run
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How much the firm
should make?
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What is the TR?
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What is the TC?
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What is the profit?
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In this example, π > 0,
because TR > TC.
When ATCmin < P, π > 0.
What is the TR?
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What is the TC?
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What is the loss?
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In this example, π < 0,
because TR < TC.
When ATCmin > P, π < 0.
What is the TC?
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What is the TC?
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What is the profit?
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In this example, π = 0,
because TR = TC.
When ATCmin = P, π = 0.
Fixed Cost =
Variable Cost =
Total Cost =
π if produced =
π if shut down =
Shut Down Price:
P* = AVCmin
If P < P*, a firm should shut down
At P < P*, q = 0
At P > P*, q such that P = MC
Short Run supply curve is a
part of MC curve above AVC
The example of the
industry supply curve
with N identical
producers with the
individual supply curve
from the previous page.
Lecture 6
Wednesday,+June+6,+2018
18:32
