Perfect Competition

Mr. Greens Economics 2010 Dixie State College

Economics 2010 Home Page

Equal Opportunity Costs

Suppose Mr. A is equally skilled at two jobs: producing milk or selling insurance.  Suppose Mr. A is indifferent in his preference between selling insurance and producing milk.  Suppose his accountant tells him that his profit if he chooses to sell insurance will be $100,000 and his profit if he chooses to produce milk will also be $100,000.


Accounting Profit
 Revenue

Cost = Normal or Accounting

Profit  The costs that are counted by accountants are the costs of the factors of production: rents, wages, interest  Economists call these accounting costs Explicit Costs  Revenue Explicit Costs = Normal or Accounting Profit

Divergent Opportunity Costs

Suppose Mr. A is selling insurance and earning $100,000 per year, and  Suppose demand for milk increases so that yearly profits in milk production rise to $120,000.  The opportunity cost (or implicit cost) of remaining is the insurance business is .$20,000. . . .?


Economic Profit
 Normal

or Accounting Profit = Revenue Explicit Costs  Economic Profit = (Normal Profit in Industry A) (Normal Profit in Industry B)  Economic Profit = the Opportunity Cost(s) of Working in Industry A when compared to Industry B.

Industrial Organization


Continuum: Degree of Competition

Monopolistic Competition Oligopoly Monopoly

Perfect Competition Many Firms Homogenous Product

One Firm Differentiated Product Significant Barriers to Entry

No Barriers to Entry

Number of Firms


Many small firms; therefore, no single firm can effect the price.


This makes the firms are price takers. takers.

Only a few firms or one firm. therefore, each will have power to set or influence prices.
This makes the firms are price makers. makers.

Homogenous Product
If there is no difference between the product(s) of one producer and those of another producer, the product is homogenous.  If the product(s) of one producer and those of another producer can be differentiated, the product is not homogenous.


Barriers to Entry and Exit



Money?  Expertise  Sole Ownership of a Resource  Economies of Scale

Network Barriers  Patents and Copyrights  Licenses, Regulations, Taxes, etc.



Perfect Competition # of Suppliers? Many Sellers

Monopolistic Competition Many Sellers

Oligopoly Few Sellers

Monopoly One Seller

Homogenous Product? Barriers to Entry and Exit?

Homogenous Product No Barriers

Differentiated Product Brand Name Barriers

Differentiated Product Economies of Scale Barriers Significant Barriers

Market Structure

Perfect Competition # of Suppliers? Homogenous Product? Many Sellers Homogenous Product Price Takers Barriers to Entry and Exit? No Barriers

Monopolistic Competition

Oligopoly

Monopoly

Perfect Competition

P $6

P D

D Qe
Market Supply and Demand

Qmilk
Contented Cow Dairys Demand

Qmilk

The Price Taker Assumption

Q 0 1 2 3 4 5 6 7

P 6 6 6 6 6 6 6 6

TR 0 6 12 18 24 30 36 42

MR 6 6 6 6 6 6 6

Marginal Revenue

P $6

P P = D = MR

D Qe
Market Supply and Demand

Qmilk
Contented Cow Dairys Demand

Qmilk

Demand = Marginal Revenue

Cost or Price

MC ATC

Cost or Price

MC ATC AVC

AVC

AFC

AFC

Quantity

Quantity

Marginal Cost

MC
P = D = MR

$6 $4
$3 1

Qmilk

Profit Maximization

MC
P = D = MR

$6 $5 $4

Qmilk

Profit Maximization

P
$7 $6 $5 $4

MC
P = D = MR

Qmilk

Profit Maximization

P
$7 $6 $5 $4

MC
P = D = MR

Qmilk

Profit Maximization

Profit Maximization
4 pounds of milk maximizes profit because at MR = MC the producer gets the most possible additional profit without incurring any loss.

Production in Perfect Competition

Short Run  The Short-Run Shut-Down Point ShortShut Derivation of the Supply Curve  Long Run  Profit, Loss, and the Zero Profit Equilibrium  Long Run Supply Curve


Cost or Price

ATC AVC MC

P3 P2 P1 P0 Total Fixed Cost

Remaining Total Variable Cost

D=MR0

Total Variable Total Revenue Cost Q0 Quantity

The Short Run Shut-Down Point

Result
At MR0, Average Variable Cost > Marginal Revenue and Rational Firms will Shut-Down

Cost or Price

ATC AVC MC D=MR3 D=MR2 D=MR1 D=MR0

P3 P2 P1 P0 Total Revenue Total Variable Cost Q2

Remaining Total Fixed Cost

Total Fixed Cost Remaining Total Revenue

Quantity

The Short Run Shut-Down Point

Result
At MR0, Average Variable Cost > Marginal Revenue and Rational Firms will Shut-Down At MR2, Average Variable Cost < Marginal Revenue and Rational Firms will Stay Active

Cost or Price

ATC AVC MC D=MR3 D=MR2 D=MR1 D=MR0 Total Revenue Q1 Quantity

P3 P2 P1 P0 Average Variable Costs Total Revenue Average Fixed Cost

The Short Run Shut-Down Point

Result
At MR0, Average Variable Cost > Marginal Revenue and Rational Firms will Shut-Down At MR2, Average Variable Cost < Marginal Revenue and Rational Firms will Stay Active At MR1, Average Variable Cost = Marginal Revenue and Rational Firms can either ShutDown or Stay Active.

Cost or Price

ATC AVC MC

P1

D=MR1 Shut Down Point: AVC = MR Quantity

The Short Run Shut-Down Point

Cost or Price

ATC AVC MC = Supply D=MR3 D=MR2 D=MR1 D=MR0

P3 P2 P1 P0

Q1

Q2

Q3

Quantity

The Supply Curve

Price

Market for Milk

S

Cost or Price

Individual Milk Producing Firm

ATC MC MR3 MR1

MarketP3 MarketP1 D2

D1

Market Market Q1 Q3

Quantity

Q1 Q3 Qmilk

Dynamics of a Price Increase

Cost or Price

ATC MC P3

Economic Profit
Total Cost Total Revenue

MR3

Q3 Qmilk

Economic Profit

The Opportunity Cost

Suppose Mr. A is selling insurance and earning $100,000 per year.  According to the graph, there are economic profits in milk. Assume these economic profits = $20,000.  Mr. A can earn $100,000 in insurance or $120,000 by switching to milk. The opportunity cost of staying in insurance is $20,000.


Economic Profit
If there is easy entry, economic profit will act like a magnet.  People with the expertise and the inclination to produce milk enter the milk industry.  These new suppliers will bid down the price.  Suppliers will continue to enter until there is no magnet.


Price

Market for Milk

Cost or S1 Price S2

Individual Milk Producing Firm

ATC MC MR3 MR2 MR1

MarketP3 MarketP2 MarketP1 D2

D1

Market Q1

Market Q2

Quantity

Q2

Qmilk

Attraction of Profits

Cost or Price

ATC MC P3 P2
MR3 MR2

Economic Profit

Total Revenue Total Cost

Q2

Qmilk

Economic Profit

Price

Market for Milk

S1

Cost or Price
S2

Individual Milk Producing Firm

ATC MC MR3 MR1

MP3 MP1
D2

D1

MQ1 MQ3 MQ4 Quantity

Q1 Q3

Qmilk

Attraction of Profits

Competitive Equilibrium
MR = ATC  Economic Profit = 0


Cost or Price

ATC = MR Economic Profit = 0 MC ATC P1 Total Revenue Total Cost

MR1

Q1

Qmilk

Competitive Equilibrium

Price

Market for Milk

Cost or Price
S

Individual Milk Producing Firm

ATC MC

MarketP1 MarketP3 D2 D1

MR1 MR3

Market Market Quantity Q3 Q1

Q3

Q1

Qmilk

Dynamics of a Price Decrease

Cost or Price

ATC MC

P1 P3

Economic Loss Total Cost

Total Revenue Q3

MR1 MR3

Qmilk

Economic Loss

The Opportunity Cost

Suppose Mr. A is earning $80,000 a year producing milk.  Suppose Mr. A could earn $100,000 selling insurance.  The opportunity cost of staying in milk production is $20,000. The economic loss shown on the graph is $20,000.


Economic Loss
If there is easy exit, economic loss will repulse milk producers.  They will exit the milk industry for other more profitable pursuits.  This loss of suppliers will bid up the price.  Suppliers will continue to exit until the repulsion ends.


Price

Market for Milk

Cost or Price
S2 S1

Individual Milk Producing Firm

ATC MC

MP1 MP2 MP3 D2 D1

MR1 MR2 MR3

MQ2 MQ3 MQ1 Quantity

Q3 Q2Q1

Qmilk

Repulsion of Loss

Cost or Price MC ATC P2 P3

Economic Loss
MR2 MR3

Total Profit Total Cost Q3 Q2

Qmilk

Economic Loss

Price

Market for Milk

S2

Cost or Price
S1

Individual Milk Producing Firm

ATC MC

MP1 MP3 D2 D1

MR1 MR3

MQ4 MQ3 MQ1 Quantity

Q3 Q2Q1

Qmilk

Repulsion of Loss

Competitive Equilibrium
MR = ATC  Economic Loss = 0


Cost or Price

ATC = MR Economic Loss = 0 MC ATC P1 Total Revenue Total Cost

MR1

Q1

Qmilk

Competitive Equilibrium

Perfect Competition # of Suppliers? Homogenous Product? Many Sellers Homogenous Product Price Takers Barriers to Entry and Exit? No Barriers Zero Economic Profit or Loss

Monopolistic Competition

Oligopoly

Monopoly

Perfect Competition

Price

Market for Milk

S1 S2

P2

P1
D2

Long Run Supply Curve

D1

Q1 Q3

Q4

Quantity

Long Run Supply Curve

The End