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ECO 211 Chapter 12.pdf

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ECO 211

Chapter  12  Compe▯▯on Compe▯▯on w What  is  perfect  compe▯▯on? w How  are  price  and  output  determined  in  a  compe▯▯ve  industry? w Why  do  firms  enter  and  leave  an  industry? w How  do  changes  in  demand  and  technology  affect  an  industry? w Why  is  perfect  compe▯▯on  economically  efficient? Perfect  Compe▯▯on w Perfect  compe▯▯on  arises  when: § There  are  many  firms,  each  selling  an  iden▯cal  product. § There  are  many  buyers. § There  are  no  restric▯ons  on  entry  into  the  industry. § Firms  in  the  industry  have  no  advantage  over  poten▯al  new  entrants. § Firms  and  buyers  are  completely  informed  about  other  firms’  prices. • Every  firm  in  a  compe▯▯ve  industry  is  a  price  taker • Market  sets  the  price • Constant  price  facing  every  firm • Choice  is  made  only  how  much  to  produce  and  sell The  Firm  Has  No  Control  Over  the  Price  It  Charges w Since  each  firm  produces  a  small  frac▯on  of  total  industry  output  and  the  products  are  iden▯cal,  no  firm  has  any   control  over  price. w Firms  are  price  takers  in  perfectly  compe▯▯ve  markets.    A  price  taker  is  a  firm  that  cannot  influence  the  price  of  a   good  or  service. Elas▯city  of  Industry  and  Firm  Demand w A  price  taker  firm  faces  a  demand  curve  that  is  perfectly  elas▯c  (horizontal)  because  the  product  from  firm  A  is  a   perfect  subs▯tute  for  the  product  from  firm  B. w However,  the  market  demand  curve  will  s▯ll  slope  downward;  elas▯city  will  be  posi▯ve,  but  not  infinite. Compe▯▯on  in  the  Real  World w In  reality,  there  are  no  markets  that  are  absolutely  perfectly  compe▯▯ve. w However,  compe▯▯on  in  some  industries  is  so  fierce  that  the  model  of  perfect  compe▯▯on  predicts  extremely   well  how  firms  will  behave. w Examples  are  computers,  so▯  drinks,  TVs,  DVD  players,  potato  chips,  etc. Economic  Profit  and  Revenue w Total  revenue  (TR) § Value  of  a  firm’s  sales § TR  =  P  ×  Q w Marginal  revenue  (MR)   § Change  in  total  revenue  resul▯ng  from  a  one-­‐unit  increase  in  quan▯ty  sold. § MR  =   TR/   Q w Average  revenue  (AR)   § Total  revenue  divided  by  the  quan▯ty  sold  —  revenue  per  unit  sold. § AR  =  TR/Q  =  PxQ/Q  =  P w In  perfect  compe▯▯on,  Price  =  MR  =  AR Economic  Profit  and  Revenue • Suppose  Cindy  sells  her  sweaters  in  a  perfectly  compe▯▯ve  market.  What  are  Cindy’s  TR,  MR,  and  AR? Demand,  Price,  and  Revenue  in  Perfect  Compe▯▯on • Price  is  fixed  is  how  we  know  a  market  is  in  perfect  compe▯▯on. • For  compe▯▯ve  firms,  Price,  Marginal  Revenue,  and  Average  Revenue  are  the  same  because  they  are  price  takers Demand,  Price,  and  Revenue  in  Perfect  Compe▯▯on Economic  Profit  and  Revenue w The  firm’s  goal  is  to  maximize  economic  profit. w Total  cost  is  the  opportunity  cost  —  including  normal  profit. • Economic  profit:  include  opportunity  cost  (not  like  accoun▯ng  profits) The  Firm’s  Decisions  in  Perfect  Compe▯▯on w A  firm’s  task  is  to  make  the  maximum  economic  profit  possible,  given  the  constraints  it  faces. w In  order  to  do  so,  the  firm  must  make  two  decisions  in  the  short-­‐run,  and  two  in  the  long-­‐run. The  Firm’s  Decisions  in  Perfect  Compe▯▯on w Short-­‐run   § A  ▯me  frame  in  which  each  firm  has  a  given  plant  and  the  number  of  firms  in  the  industry  is  fixed w Long  run   § A  ▯me  frame  in  which  each  firm  can  change  size  of  its  plant  &  decide  whether  to  leave/stay  in  industry. The  Firm’s  Decisions  in  Perfect  Compe▯▯on w In  the  short-­‐run,  the  firm  must  decide: § Whether  to  produce  or  to  shut  down. § If  the  decision  is  to  produce,  what  quan▯ty  to  produce. § Price  is  not  a  decision  because  firm  is  a  price  taker. The  Firm’s  Decisions  in  Perfect  Compe▯▯on w 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. Total  Revenue,  Total  Cost,  and  Economic  Profit • Short  run  /  Fixed  Cost:  22  /  Profits  if  she  does  not  produce:  -­‐  22 • Costs  her  23  dollars  (TC)  to  produce  1st  sweater,  TR  of  1st  sweater-­‐Fixed  Cost,  TR  of  1st  sweater-­‐TC  =  $2 • She  will  produce  9  sweaters  and  she  will  make  42  dollars  per  day  in  profit. • MC:  the  first  one  is  blank • 23 • 21 • 19 • 15 • 14 • 12 15 • • 19 • 23 • 27 • 35 • 55 • 60 • MR:  first  one  is  blank,  the  rest             Total  Revenue,  Total  Cost,  and  Economic  Profit • Green  line  Slope=marginal  revenue=25 Points  where  they  meet:  break-­‐even • • Difference  between  green  and  red:  economic  profit Total  Revenue,  Total  Cost,  and  Economic  Profit • Not  producing:  profit  is  -­‐22,  which  is  fixed  costs Total  Revenue,  Total  Cost,  and  Economic  Profit Break-­‐even  Output w An  output  at  which  total  cost  equals  total  revenue  is  called  a  break-­‐even  point. w Even  though  economic  profit  is  zero  at  break-­‐even  output,  the  firm  s▯ll  earns  a  normal  profit. w Remember,  normal  profit  is  part  of  total  (opportunity)  cost. Total  Revenue,  Total  Cost,  and  Economic  Profit Total  Revenue,  Total  Cost,  and  Economic  Profit Marginal  Analysis w Using  marginal  analysis,  a  comparison  is  made  between  a  units  marginal  revenue  and  marginal  cost. Marginal  Analysis w If  MR  >  MC,  the  extra  revenue  from  selling  one  more  unit  exceeds  the  extra  cost. § The  firm  should  increase  output  to  increase  profit w 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 w If  MR  =  MC  economic  profit  is  maximized. Profit-­‐Maximizing  Output      Profit-­‐Maximizing  Output • MR  is  fixed=Price Economic  Profit  in  the  Short  Run w Maximizing  economic  profit  does  not  guarantee  that  profits  will  be  posi▯ve. w Economic  profit  can  be  posi▯ve,  nega▯ve  or  zero. w To  calculate  total  profit,  we  must  subtract  total  cost  from  total  revenue. Price,  Average  Total  Cost,  and  Profit w Price  is  total  revenue  per  unit,  or  average  revenue  (P=AR=TR/Q) w Average  total  cost  is  total  cost  per  unit  (ATC=TC/Q). w Profit  =  TR  -­‐  TC w Profit  per  unit=(TR-­‐TC)/Q=TR/Q-­‐TC/Q w                                                =  (P  -­‐  ATC)           w That  means  we  can  calculate  total  profit  as  (P  -­‐  ATC)xQ. Profits  and  Losses  in  the  Short-­‐Run w As  we  indicated,  at  short-­‐run  equilibrium  firms  may: § Earn  a  profit § Break  even § Incur  an  economic  loss. Profits  and  Losses  in  the  Short-­‐Run w If  price  equals  average  total  cost  (P=ATC),  a  firm  breaks  even. w If  price  exceeds  average  total  cost  (P>ATC),  a  firm  makes  an  economic  profit. w If  price  is  less  than  average  total  cost  (PATC nd • 2  Graph:  P=MC • P=ATC • 3  Graph:  P=MC • P<  ATC • For  profit  maximiza▯on,  you  nee
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