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session_07_ch_8_perfect VIDEO LECTURE

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					Outline
          Session 7 Perfect Competition
               Chapter 8 in the text
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          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   END
                Wal-Mart engaging in price
Outline
                      competition
             CHAPTER 8
   •PRICING WARS ARE AN EXAMPLE OF
   COMPETITION AMONG FIRMS
   •Wal-Mart Fires the First Shot in Holiday-Toy
   Pricing War
   In late September, a full three months before
   Christmas, and a month before hot holiday items
   normally are promoted, Wal-Mart Stores slashed
   the price on Fisher-Price's newest dancing doll to
   $19.46 -- a stunning 22% discount to the Toys "R"
   Us price of $24.99.
   •The steep and early price cuts are roiling the
   industry. Yesterday, Toys "R" Us acknowledged
   Wal-Mart's moves caught it by surprise and hurt its
   third-quarter results.
   • Source: Ann Zimmerman, Joseph Pereira and
   Queena Sook Kim. Wall Street Journal (Eastern
   edition). New York, N.Y.: Nov 19, 2003. p. B.1                    E-tailing

                                                         Source: WSJ 12/8/03
                                                                                                2
            Begin 2. Structure      3.Profit 4.Shut Down     5.Supply          6.Shifts 7 Eff       END
          eBay as a source of price information
Outline
          For years, eBay Inc. has let its users buy and
          sell almost anything. Now it wants to become
          the blue book for just about everything.
          Earlier this year, the auction Web site quietly
          began selling to other companies huge volumes
          of data related to the site's auctions. Among
          the hottest data for sale: the average selling
          prices on eBay of all kinds of products, from
          Sony DVD players to Ford Explorers.
          EBay is making the push at a time when its site
          has grown monstrously large, with enough
          auctions of items across various categories that
          the company says it can provide representative
          market prices.
          eBay is a source of price information for
          consumers and makes sellers price products
          competitively. This information contributes to
          making the demand curves facing the firms be
          horizontal.
          Source: WSJ 12/8/03 At eBay Even Sales Prices are for Sale, By Nick
          Wingfield




Outline

                                                                                                            3
            Begin 2. Structure                   3.Profit 4.Shut Down           5.Supply   6.Shifts 7 Eff       END
          Session 7 Lecture Outline: Perfect Competition
Outline


               1.0 First Slide
               2.0 The Market Structure of Perfect Competition
               3.0 Profit Maximization
               4.0 Break Even and Shut Down Points
               5.0 Supply Curve
               6.0 Demand Shifts
               7.0 Efficiency
               Last Slide: Review




                                                                                  4
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff       END
          2.0 Market Structure
Outline

          2.1 Terminology
          2.2 Perfect Competition
          2.3 Market Structure Matrix
          2.4 Summary of Formulas




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   END
                     2.1 Market Structure
Outline                  Terminology
      Key Characteristics Describing Market
      Structure
          Number of suppliers
           • Many or few
          Product’s degree of uniformity
           • Do firms in the market supply identical products or are
             there differences across firms?
          The ease of entry into the market
           • Can new firms enter easily or are they blocked by natural
             or artificial barriers?
          Control over Price
Outline
           • Do sellers have full control over the selling price?
                                                                                  6
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff       END
                 2.2 The Perfectly Competitive Market
Outline
                              Structure
          Perfect Competition
            Many buyers and sellers  so many that each buys
            and sells only a tiny fraction of the total amount
            exchanged in the market
            Firms sell a standardized or homogeneous product
            Sellers has no control over price, is a price taker, it
            is determined by the market.
            Firms and resources are freely mobile  over time
            they can easily enter or leave the industry

Outline

                                                                                    7
            Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff       END
          2.3 Market Structure Matrix
Outline
                    # of suppliers Product      Entry/Exit       Control over
                                   Standardized                  Price

      Perfect       Many          Yes              Very easy     None
      Competition
      (Session 7)
      Monopoly      One           Unique, no       Blocked       Considerable
      (Session 8)                 close
                                  substitutes
      Monopolistic Many           Not much as      Relatively    Some, but
      Competition                 much             easy          within narrow
      (Session 9)                 differences as                 limits
                                  they want you
                                  to think
      Oligopoly     Few           Not much         Significant   Limited by
                                                                 interdependence,
      (Session 9)                                  obstacles
                                                                 but considerable
                                                                 with collusion
                                                                            8
          2.4 Summary of Formulas
Outline
          Profit = TR – TC
          REVENUE:
            Total Revenue: TR = q  p
            Average Revenue: AR = TR / q
            Marginal Revenue: MR = TR/ q
          COST:
            Total Cost: TC = FC + VC
            Average Variable Cost: AVC = VC / q
            Average Fixed Cost: AFC = FC / q
            Average Total Cost: ATC = TC / q
            Marginal Cost: MC=TC/ q
Outline

                                                                                  9
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff       END
          3.0 Profit Maximization
Outline

     3.1 Horizontal (price taker)
     3.2 Revenue Concepts
     3.3 Profit = TR – TC
     3.4MR = MC Approach
     3.5 Graphically
     3.6 Econ Lab




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   END
                           3.1 A Graphic Illustrating Market Equilibrium and
Outline
                           the Firm’s Demand Curve in Perfect Competition

The market price of wheat of $5 per bushel is determined in the left panel by the
intersection of the market demand curve and the market supply curve. Once the market
price is established, any farmer can sell all he or she wants at that market price.

                               (a) Market Equilibrium                                   (b) Firm’s Demand


                                                   S




                                                              Price per bushel
   Price per bushel




                      $5                                                         $5                               d




                                                   D
Outline
                                               Bushels of                                                  Bushels of
                      0            1,200,000 wheat per day                       0        5      10   15 wheat per day
                           Begin 2. Structure   3.Profit 4.Shut Down                  5.Supply   6.Shifts 7 Eff   11   END
                       3.2 Revenue Concepts
Outline
          The Demand Curve represents the Price each output is sold at.
          Marginal Revenue is the change in total revenue attributable to each
          additional unit sold.  MR = chg TR / chg q
          Because the perfectly competitive firm sells each additional unit at the
          same price, the Marginal Revenue Curve is the Demand Curve.
          Average Revenue is the ratio of total revenue to total quantity sold. It
          represents the average price received for each unit.  AR = TR / q
          Because the perfectly competitive firm sells each additional unit at the
          same price, the Marginal Revenue Curve is the Average Revenue Curve.
          Regardless of the rate of output, the following equality holds along the
          firm’s demand curve
              Market price = marginal revenue = average revenue




                                                                                   12
           Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                                   3.3a Profit
Outline
          The firm maximizes economic profit by finding the
          rate of output at which total revenue (TR) exceeds
          total cost (TC) by the greatest amount
             Profit = TR - TC


          Total revenue is simply output times the price per
          unit
             TR = P x q


          First will will show from hypothethical data where
          the profit maximizing output level is, then we will
Outline   show how this can be determined using the
          relationship MR = MC
                                                                                  13
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
             3.3b Profit, Hypothethical Firm
Outline
                                                                                                     The individual farmer’s
                                                                                                     output possibilities
      (1)      (2)    (3) = (1)  (2)   (4)          (5)     (6) = (4) + (1)    (7) = (3) - (4)      measured in bushels of
  Bushels of Marginal                                                                                wheat per day are
   Wheat     Revenue     Total        Total      Marginal    Average            Economic
   per day (Price)     Revenue        Cost        Cost       Total Cost          Profit or           shown in column (1)
     (q)       (p)    (TR = q  p) (TC)         MC=TC/  Q ATC =  / q
                                                                   TC          Loss = TR - TC
                                                                                                     Column (2) has the
      0          --        $0         $15.00          --                          -$15.00
      1         $5          5          19.75        $4.75       $19.75             -14.75            market price.
      2           5        10          23.50         3.75        11.75             -13.50
      3           5        15          26.50         3.00         8.83             -11.50            Total revenue is in
      4           5        20          29.00         2.50         7.25               -9.00
      5           5        25          31.00         2.00         6.20               -6.00           column (3) = column (1)
      6           5        30          32.50         1.50         5.42               -2.50            column (2)  P  q
      7           5        35          33.75         1.25         4.82                1.25
      8           5        40          35.25         1.50         4.41                4.75
      9           5        45          37.25         2.00         4.14                7.75           Total cost is shown in
     10           5        50          40.00         2.75         4.00              10.00            column (4)
     11           5        55          43.25         3.25         3.93              11.75
     12           5        60          48.00         4.75         4.00              12.00
     13           5        65          54.50         6.50         4.19              10.50
                                                                                                     Economic Profit is in
     14           5        70          64.00         9.50         4.57                6.00           column (7) = Total
     15           5        75          77.50        13.50         5.17               -2.50           revenue in column (3)
     16           5        80          96.00        18.50         6.00             -16.00            minus Total cost in
Outline                                                                                              column (4)


              Begin 2. Structure               3.Profit 4.Shut Down            5.Supply           6.Shifts 7 Eff    14   END
           3.3c: Short-Run Profit Maximization Graph
Outline
                                                         (a) Total Revenue Minus Total Cost
At output less than 7 bushels
and greater than 14 bushels,                                              Total cost    Total revenue
total cost exceeds total                                                                (= $5 × q )
revenue  economic loss
measured by the vertical                           $60
                                                                                 Maximum economic
distance between the two                                                         profit = $12
curves.                                             48



                                   Total dollars
Total revenue exceeds total
cost between 7 and 14 bushels
per day  economic profit is
maximized at the rate of
output of 12 bushels of wheat                       15

per day.

                                                     0    5   7      10     12         15      Bushels of wheat per day




           Begin 2. Structure   3.Profit 4.Shut Down              5.Supply       6.Shifts 7 Eff           15   END
                                3.4a MC = MR Approach
Outline
   The profit-maximizing rate of output occurs where marginal revenue equals
   marginal cost
   Marginal revenue, MR, is the change in total revenue from selling another unit of
   output
          MR = TR/ q
   Since the firm in perfect competition is a price taker, marginal revenue from
   selling one more unit is the market price  MR = P
   Marginal cost (MC) is the change in total cost resulting from producing another
   unit of output
          MC=TC/ Q
   The next slide provides an example in a Tables we look for where the output
   level where the difference between MR and MC is smallest, and the slide after
   that shows the same in a graph




                                                                                   16
           Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
             3.4b Hypothethical Firm
Outline

                           (1)        (2)    (3) = (1)  (2)   (4)         (5)     (6) = (4) + (1)    (7) = (3) - (4)
Marginal revenue is      Bushels of Marginal
presented in column       Wheat     Revenue     Total        Total     Marginal    Average            Economic
                          per day (Price)     Revenue        Cost       Cost      Total Cost           Profit or
(2) while marginal          (q)       (p)    (TR = q  p) (TC)        MC=TC/ Q ATC = TC / q        Loss = TR - TC
cost is in column (5).
                                                                                        
                             0          --        $0         $15.00         --                          -$15.00
                             1         $5          5          19.75       $4.75       $19.75             -14.75
The firm will                2           5        10          23.50        3.75        11.75             -13.50
increase quantity            3           5        15          26.50        3.00         8.83             -11.50
supplied as long as          4           5        20          29.00        2.50         7.25               -9.00
                             5           5        25          31.00        2.00         6.20               -6.00
each additional unit         6           5        30          32.50        1.50         5.42               -2.50
adds more to total           7           5        35          33.75        1.25         4.82                1.25
revenue that to total        8           5        40          35.25        1.50         4.41                4.75
                             9           5        45          37.25        2.00         4.14                7.75
cost  as long as           10           5        50          40.00        2.75         4.00              10.00
marginal revenue            11           5        55          43.25        3.25         3.93              11.75
exceeds marginal            12           5        60          48.00        4.75         4.00              12.00
                            13           5        65          54.50        6.50         4.19              10.50
cost.                       14           5        70          64.00        9.50         4.57                6.00
                            15           5        75          77.50       13.50         5.17               -2.50
                            16           5        80          96.00       18.50         6.00             -16.00

                           Marginal revenue exceeds marginal cost for the first 12 bushels of wheat.
                           The farmer, as a profit-maximizer will limit output to 12 bushels per day.


             Begin 2. Structure              3.Profit 4.Shut Down         5.Supply      6.Shifts 7 Eff                  17   END
                  3.5: Profit Maximization Graphically
Outline
The marginal cost curve intersects
the marginal revenue curve at point
                                                          (b) Marginal Cost Equals Marginal Revenue
e where output is 12 bushels per day.
At rates of output less than 12
bushels, marginal revenue exceeds
marginal cost  firm can increase                                                    Marginal cost

profit by expanding output. At                                                             Average total cost
higher rates of output, marginal
cost exceeds marginal revenue 
                                                                             e
the firm could increase profit by $5                                                       d = Marginal revenue
                                                        Profit                               = average revenue
reducing output.
                                      4                                          a
Profit appears in the blue shaded
rectangle. The height of the
                                     Dollars per unit




rectangle, ae, equals the price of
$5 minus the average cost of $4
 per unit profit of $1 per
bushel.


                                                                                           Bushels of wheat per day
                                           0                     5      10   12       15
           Begin 2. Structure    3.Profit 4.Shut Down                 5.Supply        6.Shifts 7 Eff              18   END
          3.6 Econ Lab
Outline




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   19   END
          Click to advance to next slide
Outline




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   20   END
           4.0 BREAK EVEN , SHUT DOWN POINTS
Outline

          4.1 Shut Down
          4.2 Break Even




                                                                                  21
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                  4.1a Minimizing Short-Run
Outline                    Losses
          Sometimes the price that the firm is
          required to “take” will be so low that no rate
          of output will yield an economic profit
          Faced with losses at all rates of output, the
          firm has two options
             It can continue to produce at a loss, or
             Temporarily shut down
             It cannot exit (go out of business) in the short
             run because by definition the short run is a
Outline      period too short to allow existing firms to leave
             or new firms to enter
                                                                                  22
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                4.1b Fixed Cost and Minimizing
Outline                     Losses
          The firm has two types of costs in the short
          run
             Fixed cost
             Variable cost
          A firm that shuts down in the short run must
          still pay its fixed costs
          But, by producing, a firm’s revenue may
          more than cover variable cost  a firm will
          produce if the revenue thus generated
          exceeds the variable cost of production 
Outline   can cover a least a portion of its fixed cost
                                                                                  23
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                                                      4.1c Shut Down Decision
Outline
At a price as low as p1, the
firm will shut down rather
than produce at point 1,
because the price is below                                                                  Marginal cost
average variable cost at all
output rates  the loss-
minimizing output rate at
a price of p1 is zero as
shown by q1
At a price of p2, the firm
                                                                                               Average variable cost
will be indifferent between
producing q2 and shutting                                                    2
down because either way            p2                                                                          d2
                                   p1                                  1
the loss will equal fixed                                                                                      d1
                               Dollars per unit




cost since the price just
equals average variable
cost. Point 2 is called the                                   Shutdown
shutdown point.                                               point


                                                  0                                             Quantity per period
                                                                             q         q
                                                  q
                                                                             2         5
                                                  1
            Begin 2. Structure                        3.Profit 4.Shut Down       5.Supply    6.Shifts 7 Eff   24   END
                                               4.2 Break-even
Outline
If the price is p3, the firm
will produce q3 to minimize
its loss while at p4, the                                                   Marginal cost
fiPowerpoint Lecture                                      Break-even
Notesrm will produce q4 to                                point
earn just a normal profit                                             5
                             p5                                                                   d5
the break-even point.                                                        Average total cost
If the price rises to p5, the p                                    4
                                                                                               d
firm will earn a short-run 4                                   3           Average variable cost 4
                              p3                                                               d3
economic profit by
producing q5                  p                            2
                                   2                  1                                           d2
                                  p1
In the long run all costs                                                                         d1
                            Dollars per unit




are variable (i.e. there is
no AFC cueve, and the                   Shutdown
AVC is the ATC curve) ,                 point
hence in the long run
the break-even point is       0
                              q                     q q q q                      Quantity per period
the also the shut down
point                         1                     2 3 4 5

            Begin 2. Structure 3.Profit 4.Shut Down 5.Supply                 6.Shifts 7 Eff   25   END
          5.0 Supply Curve
Outline

                       5.1 Firm’s Short Run Supply
                       5.2 Market Supply




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   END
                 5.1a Short-Run Firm Supply
Outline                     Curve
          As long as the price covers average
          variable cost, the firm will supply the
          quantity resulting from the intersection of
          its upward-sloping marginal cost curve and
          its marginal revenue, or demand curve

          Thus, that portion of the firm’s marginal
          cost curve that intersects and rises above the
          lowest point on its average variable cost
          curve becomes the short-run firm supply
Outline   curve
                                                                                  27
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                                         5.1b: Short-Run Supply Curve
Outline
The quantity supplied when the
price is p2 or higher is
determined by the intersection
of the firm’s marginal cost                                                                   Marginal cost
curve and its demand or
marginal revenue curve.
The solid portion of the           p5                                                    5
                                                                                                                    d5
short-run supply curve                                                                         Average total cost
indicates the quantity the                                                           4
                                   p4                                                                            d
firm is willing and able to                                                                  Average variable cost 4
                                   p3                                            3
supply in the short run at                                                                                       d3
each alternative price.           p2                                        2
                                                                      1                                             d2
The short-run supply              p1
                                                                                                                    d1
curve is the upward-
                              Dollars per unit




sloping portion of the
marginal cost curve,
beginning at point 2.
                                                 0                                                 Quantity per period
                                                                            q q q q
                                                 q
                                                                            2    3 4 5
                                                 1
           Begin 2. Structure                        3.Profit 4.Shut Down       5.Supply       6.Shifts 7 Eff   28   END
                          5.2a Aggregating Individual Supply to Form Market
                                                Supply
Outline


                          (a) Firm A        (b) Firm B         (c) Firm C           (d) Industry, or market, supply


                               SA                 SB                 SC                     SA+ SB+ SC = S
    Price per unit




                     p'                p'                 p'                   p'
                     p                 p                  p                    p




                     0    10 20        0     10 20        0     10 20          0             30       60
                            Quantity           Quantity           Quantity                                  Quantity
                          per period         per period         per period                                 per period


The short-run industry supply curve is the horizontal sum of all firms’ short-run supply
curves  horizontal summation of the firm level marginal cost curves

At a price below p, no output is supplied. At a price of p, each of the three firms supplies 10
units, for a market supply of 30 units, and at a price of p', each firm supplies 20 units  the
market supply is 60 units.
                          Begin 2. Structure 3.Profit 4.Shut Down
                                         Outline                             5.Supply     6.Shifts 7 Eff        29   END
                         5.2b Relationship Between Short-Run Profit
Outline
                            Maximization and Market Equilibriuim
                               (a) Firm                                 (b) Industry, or market
 Dollars per unit




                                                       Price per unit
                                                                                       SMC = S
                                     MC = s


                                          ATC
                                          AVC
                $5                               d               $5
                     Profit
                 4
                                                                                           D



                              Bushels of wheat                                 Bushels of wheat
       0        5     10 12   per day                  0           1,200,000              per day
If we suppose there are 100,000 identical wheat farmers, their individual supply curves are summed
horizontally to yield the market supply curve which is shown in the right panel where the market price
of $5 is determined. At this price, each farmer produces 12 bushels per day, as shown in the left panel,
for a total quantity supplied of 1,200,000 bushels per day  each farmer earns an economic profit of
$12 per day as shown by the blue shaded rectangle.
                       Begin 2. Structure   3.Profit 4.Shut Down 5.Supply
                                                              Outline              6.Shifts 7 Eff   30   END
          6.0 Demand Shifts
Outline

                               6.1 Equilibrium
                               6.2 Demand Increase
                               6.3 Demand Decrease
                               6.4 Practice




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   END
                         6.1 Long Run Equilibrium for the Firm and the Industry
Outline



                               (a) Firm                                (b) Industry, or market

                                    MC                                                   S
  Dollars per unit




                                          ATC




                                                  Price per unit
                                           LRAC

                                e
                     p                      d                      p

                                                                                         D




       0              q Quantity per period           0                 Q       Quantity per period
In the long run, market supply adjusts as firms enter or leave, or change their size. This process
continues until the market supply intersects the market demand at a price that equals the lowest point
on each firm’s long-run average cost curve  at point e with each firm producing q units. At point e,
marginal cost, short-run average total cost and long-run average cost are all equal.
             Begin 2. Structure 3.Profit 4.Shut Down 5.Supply 6.ShiftsOutline          7 Eff 32 END
                  6.2a: Long-Run Adjustment to an Increase in Demand
Outline
                                                      Return to 6.0 Demand Shifts
                                       (a) Firm                                            (b) Industry, or Market
                                                                                                                S
                                                      MC
    Dollars per unit




                                                                    Price per unit
                       p'                                  d'                        p'                      b
                                   Profit             ATC
                                                       LRAC
                                                                                                     a
                       p                                   d                         p

                                                                                                                         D'

                                                                                                                    D
                       0                               Quantity                                                          Quantity
                                            q    q'                                  0               Qa    Qb
                                                      per period                                                        per period
Suppose the initial point of equilibrium is given as point a in the right hand panel where the market
clearing price is p and the market quantity is Qa  the individual firm supplies q units and earns a
normal profit.
Now suppose market demand increases as shown by the shift from D to D'  the market price
increases in the short run to p'. Each firm responds to the higher price by expanding output
along its short-run supply, or marginal cost curve  the quantity supplied increases to q'      Outline
                            Begin 2. Structure    3.Profit 4.Shut Down                    5.Supply       6.Shifts 7 Eff       33   END
                       6.2b: Long-Run Adjustment to an Increase in Demand
Outline
                                                  Return to 6.0 Demand Shifts
                                       (a) Firm                                                (b) Industry, or Market
                                                                                                                    S
                                                      MC                                                                     S'
    Dollars per unit




                                                                        Price per unit
                       p'                                    d'                          p'                      b
                                                      ATC
                                                       LRAC
                                                                                                         a              c
                       p                                    d                                                                     S*
                                                                                         p

                                                                                                                                  D'

                                                                                                                        D
                       0                                     Quantity                                                               Quantity
                                         q       q'        per period                    0               Qa    Qb       Qc        per period
In the long run, economic profit attracts new firms  additional supply to the market shifting out the
market supply curve  market price to fall. Firms continue to enter as long as they earn economic
profit  the market supply eventually shifts out to S', where it intersects D' at point c, returning price
to its initial equilibrium level, p  the demand curve facing the individual firm shifts back down from
d' to d  firms again earning a normal profit. Even though industry output increases from Qa to Qb,
each firm’s output returns to q  new firms provide the additional output

                            Begin 2. Structure    3.Profit 4.Shut Down                        5.Supply       6.Shifts 7 Eff
                                                                                                                  Outline              34   END
                          6.3a: Long-Run Adjustment to a Decrease in Demand
Outline                                          Return to 6.0 Demand Shifts
                                      (a) Firm                                        (b) Industry, or Market

                                                                                                                  S
                                                 MC




                                                                Price per unit
                                                      ATC
  Dollars per unit




                                                      LRAC

                                       e                                                                 a
                     p                                   d                       p
                          Loss
                                                                                 p"                  f                D
                     p"                                  d"
                                                                                                         D"


                     0           q"    q Quantity        0                Qg Qf Qa Quantity
                                      per period                                        per period
Again, suppose that the initial long-run equilibrium is shown by point a in the market and point e
for the firm. Now suppose that market demand for this product declines from D to D"  the
market price falls to p"  the demand curve facing each firm drops to d"
Each firm responds in the short run by cutting its output to q", where marginal cost equals the now-
lower marginal revenue. Market output falls to Qf  each firm operates at a loss as shown by the red
shaded area.
                           Begin 2. Structure     3.Profit 4.Shut Down                5.Supply   6.Shifts 7 Eff       35   END
                          6.3b: Long-Run Adjustment to a Decrease in Demand
Outline
                                      (a) Firm                                      (b) Industry, or Market

                                                                                                     S"          S
                                                 MC




                                                              Price per unit
                                                      ATC
  Dollars per unit




                                                      LRAC

                                       e                                                    g             a
                     p                                  d                      p                                     S*
                          Loss
                                                                               p"                f                   D
                     p"                                 d"
                                                                                                          D"


                     0           q"    q           Quantity                    0           Qg   Qf        Qa     Quantity
                                                 per period                                                    per period

The short-run loss, if it continues, will in the long run force some firms out of this business  market
supply will decrease from S to S"  price increases back to p and the new market equilibrium is
shown by point g. Market output has fallen to Qg and the remaining firms are just earning a normal
profit as firm demand shifts back to d.

                           Begin 2. Structure                       Return to 6.0 6.Shifts 7 Eff
                                                 3.Profit 4.Shut Down 5.Supply Demand Shifts
                                                       Outline                                                       36   END
          6.4a Draw Demand Shifts
Outline   You can draw and drop the objects to practice demand shifts


                                                                    For example: In
                                                                    the right graph
                                                                    draw the
                                                                    diagram of
                                                                    market price, in
                                                                    the left draw the
                                                                    firm
                                                                    equilibrium, in
                                                                    the right
                                                                    increase
                                                                    demand and in
                                                                    the left show the
                                                                    profit for the
                                                                    firm using the
                                                                    dots CLICK HERE
                                                                    FOR ANSWER
                                                                                  37
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
Outline For
              6.4 B ANSWER
           example: In the right graph draw the diagraom of market price,
      in the left draw the firm equilibrium, in the right increase demand
      and in the leftshow the profit for the firm using the dots. CLICK
      HERE TO RETURN TO TOOLBOX slide




                                                                            38
          7.0 Efficiency
Outline

          7.1 Productive and Allocative Efficiency
          7.2 Productive: least cost
          7.3 Allocative: highest consumer valuation
          7.4 Graphically




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   END
          7.1 Perfect Competition and Efficiency
Outline

          How does perfect competition stack up as
          an efficient allocator of resources?

          There are two concepts of efficiency used to
          benchmark market performance
             Productive efficiency refers to producing
             output at the least possible cost
             Allocative efficiency refers to buying the output
             at the least possible price
             Perfect competition guarantees both allocative
Outline      and productive efficiency in the long run
                                                                                  40
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                 7.2 Productive Efficiency
Outline
          Aka Producer Surplus
          Productive efficiency occurs when the firm
          produces at the minimum point on its long-run
          average-cost curve  the market price equals the
          minimum average total cost

          The entry and exit of firms ensure that each firm
          produces at the minimum point on its short-run
          and long-run average cost curve

          Thus, perfect competition produces output at the
Outline   least possible cost per unit in the long run
                                                                                  41
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                  7.3 Allocative Efficiency
Outline

          Aka Consumer Surplus
          Allocative efficiency occurs when the marginal
          benefit that consumers attach to the final
          unit purchased, just equals the opportunity
          cost of the resources employed to produce
          that unit.
             The demand curve reflects the marginal benefit
             that consumers attach to each unit
          In perfect competition, at the equilibrium
          price consumers marginal benefit equals the
Outline   marginal cost of supplying the last unit sold
                                                                                  42
          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END
                                          7.4 Graphically
Outline
In the short run, producer surplus is
the total revenue producers are paid
minus their variable cost of production
                                               Dollars per unit
In our example, the market-clearing
price is $10 per unit, and producer
surplus is the red shaded area under
the price but just above the supply
curve.
The combination of consumer                      Consumer                                S
                                                 surplus
surplus and producer surplus
shows the gains from voluntary                                               e
exchange.                                 10
Productive and allocative efficiency             Producer
in the short run occurs at point e,              surplus
which also is the combination of          6
                                                                                              D
price and quantity that maximizes         5
the sum of consumer and producer                           m
surplus.
                                                                                 Quantity per period

                                          0            100,000 120,000       200,000
            Begin 2. Structure         3.Profit 4.Shut Down       5.Supply   6.Shifts 7 Eff       43   END
          END OF PRESENTATION
Outline
                     Pics linked to topics in lecture




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   44   END
Outline




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff        END




          Begin 2. Structure   3.Profit 4.Shut Down   5.Supply   6.Shifts 7 Eff   45   END

				
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