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Definition of Perfectly Competitive Market

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					PERFECTLY COMPETITIVE
      MARKETS
       Definition of a Perfectly
        Competitive Market
• Very Large Number of Sellers and Buyers

• Identical (Homogeneous) Product

• Easy Entry/Easy Exit

• Perfect Information
      Definition of a Perfectly
       Competitive Market

A. Very Large Number of Sellers
  –    Each firm produces an extremely small percent
       of total market supply.


B. Identical Product
  –    The product sold by one firm is identical to that
       sold by another firm.
     Definition of a Perfectly
    Competitive Market Cont’
C. Easy Entry and Easy Exit
    - Easy to enter this industry because costs are low.
    - Also easy to quit this industry because of the low
    costs.


D. Buyers and Sellers Have Perfect
   Information
     - All the buyers and sellers know all of the relevant
  information.
Consequences of a Competitive
     Market for the Firm

A. The Competitive Firm Is A Price Taker
    - The firm must take the market price as given.


B. The Competitive Firm Has No Market
   Power
     - The firm is so small that it has no power to shape
  the market in any way.
        Consequences of a
      Competitive Market for the
            Firm Cont’
C. The Competitive Firm Has A Horizontal
   Demand Curve
  –    The firm must take the market price as given, and
       then decide how much it can produce.
  –    It can sell any level of output, but only at the market
       price.
  –    Whatever levels of output it sells at, the price will stay
       the same.
The Profit Maximizing Rate
        of Output
• We wish to answer the question:
  – At what rate of output will a competitive firm
    maximize its profits?
 There Are Two Approaches
  to Answer This Question

A. Total Revenue/Total Cost

B. Marginal Revenue/Marginal Cost
         Total Revenue

• Total Revenue =

   - Price times Sales or
   - Price times Output
     Average Revenue

• Average Revenue =

 – Same as price for the competitive firm.
       Marginal Revenue

• Marginal Revenue=

    - The change in total revenue that comes
 from selling one more unit of output.
    Total Revenue/Total Cost
           Approach
• Total Profits = Total Revenue -
                  Total Costs

• Total Revenue = Price * Output
                  = Price * Sales

• Total Costs     = Fixed Costs +
                    Variable Costs
   Total Revenue/Total Cost
          Approach

• Firms maximize profits where total
  revenues are larger than total costs
  by the largest amount.
     The Marginal Cost/
  Marginal Revenue Approach
• More important than the total cost total revenue
  approach

• This is because firms use the approach to
  determine exactly what level to produce at.
          Recall That:

• Marginal Revenue =


     - Change   in total revenue from one more
 sale.
        Marginal Cost

• Marginal cost will be defined as:

    - Change   in total cost from one more
 sale.
  The Marginal Cost-Marginal
   Revenue Approach Cont’

• The approach is to examine each sale to determine
  whether the costs of production is less than, equal
  to, or greater than, the revenues generated from
  the sale of that unit.
Profit Maximization, Marginal
   Cost/Marginal Revenue
          Approach
• If a new sale from a new level of production
  generates more revenues than costs, the firm
  should produce at the new level.

• In this case marginal revenue is greater than
  marginal cost.
Profit Maximization, Marginal
   Cost/Marginal Revenue
          Approach
• If a new sale from a new level of production
  generates more costs than revenues, the firm
  should not produce at the new level.

• In this case marginal cost is greater than marginal
  revenue.
   Profit Maximization for the
    Competitive Firm Cont’
• Firms will expand output as long as:
                MR>MC

• Firms will cut back output as long as:
                MC>MR

• Firms will maximize profits at the output:
            Where MC=MR
   SHORT RUN
PROFITS AND LOSSES
 Short Run Profits and Losses

A. As long as price is greater than the
   minimum average total cost, the firm has
   profits.

                P > MIN ATC
 Short Run Profits and Losses

B. The break-even price is the price that is
   equal to the minimum ATC curve.

                P = MIN ATC
 Short Run Profits and Losses
            Cont’

C. If price falls below minimum ATC, it will
   suffer losses.

                P < MIN ATC
THE SHUT DOWN
   DECISION
 Short Run Profits and Losses:
     The Shut Down Price
A. If a firm shuts down, it will suffer a loss
   equal to its fixed costs. Investors lose all
   of their money.

B. As long as the firm can pay for some of its
   fixed costs, it should continue to produce.
 Short Run Profits and Losses:
     The Shut Down Price

C. The shut down price is the price that is
   just equal to the minimum average
   variable cost.

               P = MIN AVC
    Short Run Profits and Losses:
     The Shut Down Price Cont’

D. At any price above the minimum average
   variable cost, the firm will lose money,
   but less money than if it shuts down.

•    At any price below the minimum average
     variable cost, the firm should shut down.
  Summary of Price Decisions

• If P > MIN ATC, there will be profits.
• Produce where MR=MC

• If P = MIN ATC, the firm will break even.
• Produce where MR=MC
  Summary of Price Decisions
           Cont’
• If P < MIN ATC, but P > MIN AVC there will
  be losses.
• Produce where MR = MC

• If P < MIN ATC, and P < MIN AVC then shut
  down.
LONG RUN SUPPLY
   Constant-Cost Industries

• An industry in which expansion or
  contraction will not affect resource prices.
  Therefore production costs will stay the
  same.
   Increasing-Cost Industry

• An industry in which expansion will lead to
  a rise in resource prices and production
  costs; and contraction leads to a fall in
  resource prices and production costs
  Decreasing-Cost Industry

• An industry in which expansion will lead to
  a fall in resource prices and production
  costs; and contraction leads to a rise in
  resource prices and production costs.
 TOTAL  FIXED VARIABLE              TOTAL      MARGINAL        AVG.    AVG.     AVG.
PRODUCT COSTS   COSTS               COSTS        COSTS        FIXED VARIABLE   TOTAL
                                                              COSTS   COSTS    COSTS
     0                                 150
     1                                 350
     2                                 510

     3                                 630
     4                                 710
     5                                 750
     6                                 930
     7                                1130
     8                                1350
     9                                1590
     10                               1850

1)   Compute all costs
2)   If price is $186, compute revenues and profit max. level of output.
2)   If price is $136, compute revenues and profit max. level of output.
2)   If price is $106, compute revenues and profit max. level of output.

				
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