Get documents about "Econ 281 Chapter09.ppt - University of Alberta - Edmonton_ Alberta
Document Sample
Chapter 9: Perfect Competition
•Thus far we have examined how the
consumer and firm attempt to optimize their
decisions
•The results of this optimization depend on
the set-up of the economy
•In this course we will examine the extreme
set-ups: Perfect Competition and Monopoly
1
Chapter 9: Perfect Competition
In this chapter we will cover:
Perfect Competition Characteristics
Economic and Accounting Profit
PC Profit Maximization
PC Short Run Supply and Equilibrium
PC Long Run Supply and Equilibrium
PC Costs
Economic Rent
Producer Surplus
2
1) Fragmented Industry
-Many buyers and sellers
-No one buyer or seller has an effect on the
industry
-Each firm and consumer is a price taker (uses
market price)
2) Homogeneous products
-All firms produce identical products
-No quality differences, no brand loyalty
3
3) Perfect Information
-Buyers and sellers have full information,
especially regarding prices
4) No barriers to entry or exit
-No input is restricted to potential customers
or firms
-Any firm or customer can enter or exit the
market in the long run
4
As a result, we have:
• Many buyers and sellers
• Buying and selling identical goods
At a given, set price.
Note: although we are examining a market for
outputs, a similar analysis can apply to the
market for inputs
5
As seen before,
Accounting Costs = Explicit Costs
Economic Costs = Explicit Costs + Implicit Costs
Furthermore,
Accounting Profit = Revenue – Explicit Costs
Economic Profit = Revenue – Explicit Costs
- Implicit Costs
6
Profit: Economists vs Accountants
Economist’s Accountant’s
View View
Economic
Profit Accounting
Profit
Implicit
Revenue Costs Revenue
Economic
Costs
Explicit Explicit
Costs Costs
7
Implicit Costs are the BEST ALTERNATIVE return
of ALL of an agent’s input (time, money, etc).
Alternately, an agent’s time could earn a wage
elsewhere.
(ie: Work at Simtech for $3000 a month)
An agent’s money both isn’t used currently and
can be used elsewhere.
(ie: Investing $5,000 at 10% instead of starting a
business gives an implicit cost of $500)
8
Mikey opens up a specialized mousepad company.
Spending $5,000 a month on space and supplies,
Mikey makes $8,000 a month.
Alternately, Mikey could work at Donald Duckpads
Inc for $1,500 a month or at a reasearch lab for
$1,000 a month.
Mikey could invest in bonds at 10% return or in
stocks at 2% return. Calculate accounting and
9
economic profit
Best alternatives: Donald Inc ($1,500) and Bonds
($500).
Accounting Profits = Revenue – Explicit Costs
=$8,000-$5,000
=$3,000
Economic Profit = Revenue – Explicit Costs
- Implicit Costs
=$8,000 - $5,000 - $1,500 - $500
=$1,000
10
While previously we studied cost minimizing, in
reality a firm is more concerned with maximizing
its profits.
Total Revenue: TR(Q)=PQ
Total Cost: TC(Q) as found in previous chapters
ie: TC(Q)=100+2Q
Profit =Total Revenue – Total Cost:
π(Q)=TR(Q)-TC(Q)
11
TC(Q) in general is derived as follows:
Originally: TC=wL+rK (1)
Tangency Condition: L=f(K) (2)
Production Function: Q=f(L,K) (3)
(2) + (3) Q=f(L) and
L=f(Q) (4)
(2) + (4) K=f(Q) (5)
(1) + (4) + (5) TC=wf(Q)+rf(Q)
TC=f(Q)
12
For Example:
Originally: TC=wL+rK (1)
Tangency Condition: L=K (2)
Production Function: Q=2(LK)1/2 (3)
(2) + (3) Q=2L and
L=Q/2 (4)
(2) + (4) K=Q/2 (5)
(1) + (4) + (5) TC=wQ/2+rQ/2
TC=(w+r)Q/2
13
Definition: Marginal revenue is the change in revenue when
output changes
Marginal revenue is the slope of the total revenue curve.
Since the PC firm is a price taker, the additional revenue
gained from 1 additional output is equal to P.
TR (Q)
MR (Q) P
Q
14
As seen previously, marginal cost changes as production
increases.
If for the next unit, MR>MC, that unit should be produced,
as it yields profit.
If for the last unit, MC>MR, that unit should not have been
produced, as it decreases profit.
Therefore profit is maximized where MC=MR=P 15
Total Cost, Total Revenue, Total Profit ($/yr)
Total revenue = pq
Total Cost
Example: Profit Maximization Condition
15 Total profit
q (units per year)
MC
15 P, MR
16
6 30 q (units per year)
The previous curves are expressed by:
TC(q) = 242q - .9q2 + (.05/3)q3
MC(q) = 242 - 1.8q + .05q2
P = 15
At profit maximizing point: 1) P = MC
But this occurs twice. At one point, profit is
maximized, at another minimized. Therefore, in
order to MAXIMIZE profit:
2) MC must be rising
17
In the paper industry, MC=20+2Q (which is always
rising), where Q=100 reams of paper. Find the cost-
maximizing quantity if P=30 or P=40
Solution: P=MC
30=20+2Q
5=Q
P=MC
40=20+2Q
18
10=Q
In the short run, the firm either produces or
temporarily shuts down, thus facing costs:
STC(Q) = SFC + NSFC + TVC(q) when q > 0
SFC when q = 0
SFC: Sunk Fixed costs – unavoidable sunk costs
NSFC: Non-sunk Fixed costs – fixed costs that are
avoidable if the firm temporarily shuts down
TVC: Total Variable Costs; depends on output 19
Definition: The firm’s Short run supply curve
tells us how the profit maximizing output changes
as the market price changes.
3 Cases:
Case 1: all fixed costs are sunk
Case 2: all fixed costs are non-sunk
Case 3: some fixed costs are sunk
20
Case 1: all fixed costs are sunk
NSFC=0
STC=TVC(q) + SFC
If the firm chooses to produce a positive
output, P = SMC defines the short run
supply curve of the firm. But…
21
The firm will choose to produce a
positive output only if:
(q) > (0) …or…
Pq – TVC(q) – SFC > -SFC
Pq – TVC(q) > 0
P > AVC(q)
Definition: The price below which the firm
would opt to produce zero is called the shut
down price, Ps. In this case, Ps is the
minimum point on the AVC curve.
22
Therefore, the firm’s short run supply function is
defined by:
1. P=SMC, where SMC slopes upward as
long as P > Ps
2. 0 where P < Ps
This means that a perfectly competitive firm
may choose to operate in the short run even if
economic profit is negative.
23
$/yr Example: Short Run Supply Curve of the Firm, NSFC = 0
SMC
SAC
AVC
Ps
Quantity (units/yr)
24
At prices below SAC but above AVC, profits
are negative if the firm produces…but the firm
loses less by producing than by shutting down
because of sunk costs.
Example:
STC(q) = 100 + 20q + q2
SFC = 100 (nb: this is sunk)
TVC(q) = 20q + q2
AVC(q) = 20 + q
SMC(q) = 20 + 2q 25
a. The minimum level of AVC is the point
where AVC = SMC or…
20+q = 20+2q
q = 0
AVC minimized at p=20
b. The firm’s short run supply curve is, then:
P < Ps = 20: qs = 0
P > Ps = 20: P = SMC
P = 20+2q
qs = ½P - 10 26
Case 2: all fixed costs are non-sunk
SFC=0
STC=TVC(Q)+NSFC
If the firm chooses to produce a
positive output,
P = SMC defines the short run
supply curve of the firm. But…
27
The firm will choose to produce a positive
output only if:
(q) > (0) …or…
Pq – TVC(q) - NSFC > 0
P > AVC(q) + AFC(q) = SAC(q)
Now, the shut down price, Ps is the
minimum of the SAC curve 28
$/yr Example: Short Run Supply Curve of the Firm, All
Fixed Costs Non-Sunk
SMC
SAC
Ps AVC
Quantity (units/yr)
29
Case 3: Short Run Supply Curve
(Some costs are sunk):
NSFC≠0, SFC ≠0
Average Nonsunk Cost = Average Variable Cost +
Average Nonsunk Fixed Cost
ANSC=AVC + NSFC/Q
30
The firm will choose to produce a
positive output only if:
(q) > (0)
Pq – TVC – SFC - NSFC > -SFC
Pq – TVC - NSFC > 0
P > AVC + NSFC/Q = ANSC
Definition: The price below which the firm
would opt to produce zero is called the shut
down price, Ps. In this case, Ps is the
minimum point on the ANSC curve.
31
Therefore, the firm’s short run supply function is
defined by:
1. P=SMC, where SMC slopes upward as
long as P > Ps
2. 0 where P < Ps
This means that a perfectly competitive firm
may choose to operate in the short run even if
economic profit is negative.
32
$/yr Example: Short Run Supply Curve of the Firm
SMC
SAC
ANSC
AVC
Ps
Quantity (units/yr)
33
If all fixed costs are sunk,
(AVC=ANSC)
Shut down if P<AVC (low)
If all fixed costs are nonsunk,
(ANSC=SAC)
Shut down if P<SAC (high)
If some fixed costs are sunk, some nonsunk,
Shut down if P<ANSC (middle) 34
A firm will produce
If
It can cover its Non-Sunk Costs
35
Thus far we have seen that the individual firm’s
short run supply curve comes from their marginal
cost curve.
Definition: The market supply at any price is the
sum of the quantities each firm supplies at that
price.
The short run market supply curve is the
HORIZONTAL sum of the individual firm supply
curves. (Just as market demand is the
HORIZONTAL sum of individual demand curves)
36
Example: From Short Run Firm Supply Curve to Short Run Market Supply Curve
Typical firm: Market:
Individual supply curves
per firm. 1000 firms of each
type SMC3
$/unit SMC2 $/unit
SMC1
Market supply
30
24
22
20
0 300 400 500 0 1.2
37 mill
q (units/yr) Q (m units/yr)
Definition: A short run perfectly competitive
equilibrium occurs when the market quantity
demanded equals the market quantity supplied.
ni=1 qs(P) = Qd(P)
Qs(P)= Qd(P)
and qs(P) is determined by the firm's
individual profit maximization condition.
38
Example: Short Run Perfectly Competitive Equilibrium
Typical firm: Market:
$/unit $/unit
Supply
SMC
SAC
P*
AVC Demand
Ps
q* Units/yr 39
Q* m. units/yr
300 identical firms
Qd(P) = 60 – P
STC(q) = 0.1 + 150q2
SMC(q) = 300q
NSFC = 0
AVC(q) = 150q
40
a. Short Run Equilibrium
Profit maximization condition: P = SMC
P = 300q
qs(P) = P/300 (for each firm)
Qs(P) = P (for industry)
Qs(P) = Qd(P) P = 60 – P
P*= 30
q* = 30/300=.1
Q* = 30 41
b. Do firms make positive profits at the
market equilibrium?
SAC = STC/q = .1/q + 150q
When each firm produces .1, SAC per firm
is: .1/.1 + 150(.1) = 16
Therefore, P* > SAC so profits are positive.
42
Comparative Statics in the
Short Run
•As seen in previous chapters, the entry or exit of
firms or consumers, among other things, can shift
the market demand and supply curves
•Shifts in the market demand and supply curves
will shift the equilibrium quantity as seen in
chapters 1 and 2
43
In the short run, capital is fixed and firms may
temporarily operate under an economic profit
or loss.
In the long run, capital can change and firms can
enter and leave the market, resulting in zero
economic profit.
Remember that in the long run, all costs are
nonsunk (they are all avoidable at zero output)
44
Just as in the short run the firm operated at:
P=SMC
In the long run the firm operates at
P=MC
SMC≠MC (in general) since costs are reduced in
the long run.
Only at LR profit maximization is SMC=MC
(because the short run is operating at the LR
optimal capital point: Point A next slide)
45
$/unit In the long run, this firm has an incentive to change
plant size to level K1 from K0:
MC
A AC
P
SMC0 SAC0
•
SAC1
SMC1
q (000 units/yr)
46
1.8 6
In the long run, a firms supply curve is
The firm’s LR MC curve above AC.
For if P>AC, Profits>0.
Since Profits = (PxQ)-(ACxQ)
As in the short run, market supply is the
horizontal sum of individual firm supply.
47
$/unit Long Run Supply Curve:
MC
S AC
P
SMC1
q (000 units/yr)
48
1.8 6
Long Run Perfectly Competitive Equilibrium
occurs when:
1) Each firm maximizes profit with regards to
output and capital (P=MC)
2) Each firm’s economic profit is zero (as firms
keep entering until the price is pushed down to
zero profits) (P=AC)
3) Market Demand=Market Supply
49
Long Run Perfectly Competitive Equilibrium
Typical Firm Market
$/unit $/unit
MC Market demand
SAC AC
P*
SMC
q*=50,000 q Q*=10M. 50 Q
•to increase production, a firm must increase inputs
•If we assume that the market for inputs is a perfectly
competitive market, one industry’s input choices
have no effect on market price
•A CONSTANT COST INDUSTRY is an industry
where changes in output do not affect the price of
inputs
•This determines the LR supply curve 51
-Demand increases to D2, Price rises to P2
-New firms enter, Supply increases to S2,
lowering price to P1
$/unit $/unit
S1
SMC
SAC S2
P2
LS
P1
D2
D1
Typical Firm q Market 52 Q
•Industry-specific inputs are scarce inputs used
primarily by one industry
-ie:Plutonium is only used in the nuclear industry
•Changes in production will have an impact on
the market for industry-specific inputs
•An INCREASING COST INDUSTRY is an
industry where increases in output increase the
price of inputs 53
-Demand increases to D2, Price rises to P2
-New firms enter, Supply increases to S2,
lowering price to P3 and increasing costs
$/unit $/unit
SMC3
S1
SMC1 SAC3 S2
LS
P2
P3
P1
SAC1
D2
D1
Typical Firm q Market 54 Q
•Some industries require a small amount of an
expensive input
-ie: Blue Ray CD Drive
•An increase in input demand may drive down
input prices by reducing input AC
•A DECREASING COST INDUSTRY is an
industry where increases in output decrease the
price of inputs 55
-Demand increases to D2, Price rises to P2
-New firms enter, Supply increases to S2,
lowering price to P3 and decreasing costs
$/unit $/unit
SMC1 S1
SMC3
SAC1
P2 S2
SAC3
P1
LS
P3 D2
D1
Typical Firm q Market 56 Q
Although economic profit is possible in
the short run,
In the long run the entry of firms will
push economic profit to zero
57
• In general, we assume that all workers are
identical.
• In reality, some workers are masters; they are
more productive than their peers.
• The cost savings of a master worker is their
ECONOMIC RENT
58
Joe is an amazing worker that works in a button
factory. While most workers can only press
one or two buttons at a time, Joe can press a
dozen.
A normal worker produces buttons at an average
cost of 5 cents, but Joe can make buttons at
an average cost of 1 cent each. If Joe
produced buttons at a cost of 5 cents each,
he’d be hired to produce 900 a day.
59
Economic Rent = Cost Savings
ER = (0.05-0.01)900
ER = $90
The economic rent from a master worker (Joe) is
$90 a day.
60
• If a firm is able to employ a master worker at
a normal worker’s wage, that worker’s
economic rent becomes the firm’s economic
profit
• In a perfectly competitive industry, in all
likelihood a master worker will be stolen by
other firms at higher wages until his wage
matches his productivity
• Master workers therefore often provide no
profit in perfect competition 61
Definition: Producer Surplus is the area above
the supply curve and below the price. It is a
monetary measure of the benefit that producers
derive from producing a good at a particular price.
Note that the producer earns the price for
every unit sold, but only incurs the SMC for
each unit. This is why the difference
between the P and SMC curve measures the
total benefit derived from production.
62
$/yr Producer Surplus, Individual Firm
SMC
ANSC
P
Producer
Surplus
Quantity (units/yr)
63
Further, since the market supply curve is simply
the sum of the individual supply curves…which
equal the marginal cost curves…the difference
between price and the market supply curve
measures the surplus of all producers in the
market.
Note that producer’s surplus does not deduct
fixed costs, so it does not equal profit!
64
Market Producer Surplus
P
Market Supply Curve
50
Producer Surplus = (1/2)BH
PS=(1/2)800(40)
PS=16,000
10
Q 65
800
Producer surplus is the difference between total
revenue and total nonsunk costs;
Producer Surplus=TR-NSFC-TVC
In the short run, if Producer
Surplus>SFC, economic profit is
possible.
66
In the long run, no costs are fixed,
Therefore Producer Surplus = Economic Profit
BUT
In the long run, Economic Profit=0
How?
67
An industry has an upward sloping supply if it
employs scarce resources (increasing cost
industry – master growers)
Producer Surplus is therefore the economic rent
captured by the master worker or owner of the
input
In the LR PC: Producer Surplus=Economic Rent
68
Long Run Producer Surplus =
P Economic Rent
LS
50
Economic
Rent
D
10
Q 69
800
