MIcroeconomics - Perfect Competition

Topics: Economics, Supply and demand, Perfect competition Pages: 19 (3188 words) Published: March 27, 2014

Perfect Competition


After studying this chapter you will be able to
!  Define perfect competition
!  Explain how firms make their supply decisions and why
they sometimes shut down temporarily and lay off
!  Explain how price and output in an industry are
determined and why firms enter and leave the industry
!  Predict the effects of a change in demand and of a
technological advance
!  Explain why perfect competition is efficient

The Busy Bee
The busy bee pollinates plants and beekeepers rent their
hives to farmers.
Across the United States from Vermont to California, a
parasite is killing off bees and the rent farmers pay for hives has more than doubled.
How does competition in beekeeping and other industries
affect prices and profits?
We study a fiercely competitive market in this chapter.
We explain the changes in price and output as the firms in
perfect competition respond to changes in demand and
technological advances.

What Is Perfect Competition?
Perfect competition is an industry in which
§  Many firms sell identical products to many buyers.
§  There are no restrictions to entry into the industry. §  Established firms have no advantages over new ones. §  Sellers and buyers are well informed about prices.

What Is Perfect Competition?
How Perfect Competition Arises
Perfect competition arises:
§  When firm’s minimum efficient scale is small relative to market demand so there is room for many firms in the
§  And when each firm is perceived to produce a good or service that has no unique characteristics, so consumers
don’t care which firm they buy from.

What Is Perfect Competition?
Price Takers
In perfect competition, each firm is a price taker.
A price taker is a firm that cannot influence the price of a good or service.
No single firm can influence the price—it must “take” the equilibrium market price.
Each firm’s output is a perfect substitute for the output of the other firms, so the demand for each firm’s output is
perfectly elastic.

What Is Perfect Competition?
Economic Profit and Revenue
The goal of each firm is to maximize economic profit,
which equals total revenue minus total cost.
Total cost is the opportunity cost of production, which
includes normal profit.
A firm’s total revenue equals price, P, multiplied by
quantity sold, Q, or P × Q.
A firm’s marginal revenue is the change in total revenue
that results from a one-unit increase in the quantity sold.

What Is Perfect Competition?
Figure 11.1 illustrates a firm’s revenue concepts.
Part (a) shows that market demand and market supply
determine the market price that the firm must take.

What Is Perfect Competition?
Figure 11.1(b) shows the firm’s total revenue curve (TR)
—the relationship between total revenue and quantity sold.

What Is Perfect Competition?
Figure 11.1(c) shows the marginal revenue curve (MR).
The firm can sell any quantity it chooses at the market price, so marginal revenue equals price and the demand curve for
the firm’s product is horizontal at the market price.

What Is Perfect Competition?
The demand for the firm’s product is perfectly elastic
because one of Cindy’s sweaters is a perfect substitute for the sweater of another firm.
The market demand is not perfectly elastic because a
sweater is a substitute for some other good.

The Firm’s Decisions in Perfect
A perfectly competitive firm faces two constraints:
1. A market constraint summarized by the market price
and the firm’s revenue curves.
2. A technology constraint summarized by firm’s product
curves and cost curves (like those in Chapter 10).
The goal of the firm is to make maximum economic profit,
given the constraints it faces.
So the firm must make four decisions: Two in the short run
and two in the long run.

The Firm’s Decisions in Perfect
Short-Run Decisions
In the short run, the firm must decide:
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