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Chapter7MarketStructure:PerfectCompetitionChapter7PerfectCompetitionCharacterizedbyAlargenumberoffirmsinthemarketAnundifferentiatedproductEaseofentryintothemarketCompleteinformationavailabletoallmarketparticipantsPerfectCompetitionCharacterizPerfectCompetitionDistinguishedbetweenbehaviorofindividualfirmsandoutcomesforentiremarketNosinglefirmhasanyinfluenceonthepriceofaproductPrice-taker:afirmcannotinfluencethepriceofitsproduct,thusitcansellanyamountofoutputatthatpricePerfectCompetitionDistinguisPerfectlyCompetitiveFigure7.1Industry/MarketIndividualFirm0PEQQEDSQP0Q1MCQ2ATCD=P=MRBAPerfectlyCompetitiveFigure7.ProfitMaximizationTC
=totalcostwhereTR=totalrevenue=TR-TC=profitProfit-maximizationrule:tomaximizeprofits,afirmshouldproducethelevelofoutputwheremarginalrevenueequalsmarginalcostProfitMaximizationTC=totalMarginalRevenuePriceequalsmarginalrevenueforaperfectlycompetitivefirmbecausethefirmdoesnothavetolowerthepricetosellmoreunitsofoutputTheprofit-maximizinglevelofoutputoccurswheremarginalrevenueequalsmarginalcostbecauseanyotherlevelofoutputwillresultinsmallerprofitMarginalRevenuePriceequalsmDeterminingtheAmountofProfitEarnedIfyouknowtotalrevenueandtotalcost,youcancalculateamountofprofitUsingTRandTCfunctiongraphs,youcancalculatelevelofprofit-maximizingbyfindingthegreatestdistancebetweenthetwocurvesandcalculatetheprofitatthatpointDeterminingtheAmountofProfTheShutdownPointTheshutdownpointforperfectlycompetitivefirm:theprice,whichjustequalsAVC,belowwhichitismoreprofitablefortheperfectlycompetitivefirmtoshutdownthantocontinuetoproduceThesupplycurveisthatportionofitsmarginalcostcurveaboveminimumAVCTheShutdownPointTheshutdownSupplyCurveforPerfectlyCompetitiveIndustryThesupplycurveshowstheoutputproducedbyallperfectlycompetitivefirmsintheindustryatdifferentpricesThecurvewillbeflatterthanthefirm’ssupplycurvebecauseitreflectsoutputproducedbyallfirmsintheindustryateachpriceSupplyCurveforPerfectlyComLong-runAdjustmentTwofactors:EntryandexitbynewandexistingfirmsChangesinthescaleofoperationsbyallfirmsThesefactorscanoccursimultaneouslyLong-runAdjustmentTwofactorLong-runAdjustmentEquilibriumpointfortheperfectlycompetitivefirm:thepointwherepriceequalsATCsincethefirmearnszeroeconomicprofitatthispointEconomicprofitincorporatesallimplicitcostsofproductionincludingnormalrateofreturnoninvestmentLong-runAdjustmentEquilibriuLong-runAdjustment:
EntryandExitFigure7.3Industry/MarketIndividualFirmD20PE2QE2QE1D1S1S2QE3PE1MCATCD1=P1=MR1P0Q1Q2ABD2=P2=MR2Long-runAdjustment:
EntryanLong-runAdjustmentFirmisaprice-taker;therefore,itmustacceptnewequilibriumpriceanddetermineappropriatelevelofoutputAllfirmsknowthepositiveeconomicprofitsOtherfirmsareabletoenterthemarketLong-runAdjustmentFirmisaOptimumScale
ofProductionLRACP1=MR1P2=MR2SMC1SATC1SMC2SATC2$0Q1Q2QFigure7.5OptimumScale
ofProductionLRAOptimumScale
ofProductionInFigure7.5,LRACincorporatesbotheconomiesofscaleanddiseconomiesofscaleLarge-scaleproductionwillgivemanagerscompetitiveedgebydecreasingproductioncostsCannotinfluencepriceofproductOptimumScale
ofProductionInManagershavelittleornocontroloverproductpriceTheycompeteonbasisofloweringcostsofproductionPerfectlycompetitivefirmsearnzeroeconomicprofitbecauseentryofotherfirmscompeteawayexcessprofitManagerialRuleofThumb:CompetitionMeansLittleControlOverPriceManagershavelittleornoconOtherCompetitiveMarketsIndustryconcentration:measureofhowmanyfirmsproducethetotaloutputofanindustryPrice-costmargin(PCM):relationshipbetweenpriceandcostsforanindustryOtherCompetitiveMarketsIndusManagersincompetitiveindustriescangainmarketpowerbyMergingwithothercompaniesDifferentiatingproductsFormingproducerassociationtochangeconsumerpreferencesandincreasedemandforoutputoftheentireindustryManagerialRuleofThumb:StrategiestoGainMarketPowerManagersincompetitiveindustSummaryofKeyTermsDiseconomiesofscaleEconomiesofscaleEquilibriumpointfortheperfectlycompetitivefirmIndustryconcentrationMarginalrevenuecurvefortheperfectlycompetitivefirmCompetitivefirmPerfectcompetitionSummaryofKeyTermsDiseconomiSummaryofKeyTermsPrice-costmargin(PCM)PricetakerProfitmaximizationShutdownpointfortheperfectlycompetitivefirmSupplycurvefortheperfectlycompetitivefirmSupplycurvefortheperfectlycompetitiveindustrySummaryofKeyTermsPrice-costDoyouhaveanyquestions?DoyouhaveChapter7MarketStructure:PerfectCompetitionChapter7PerfectCompetitionCharacterizedbyAlargenumberoffirmsinthemarketAnundifferentiatedproductEaseofentryintothemarketCompleteinformationavailabletoallmarketparticipantsPerfectCompetitionCharacterizPerfectCompetitionDistinguishedbetweenbehaviorofindividualfirmsandoutcomesforentiremarketNosinglefirmhasanyinfluenceonthepriceofaproductPrice-taker:afirmcannotinfluencethepriceofitsproduct,thusitcansellanyamountofoutputatthatpricePerfectCompetitionDistinguisPerfectlyCompetitiveFigure7.1Industry/MarketIndividualFirm0PEQQEDSQP0Q1MCQ2ATCD=P=MRBAPerfectlyCompetitiveFigure7.ProfitMaximizationTC
=totalcostwhereTR=totalrevenue=TR-TC=profitProfit-maximizationrule:tomaximizeprofits,afirmshouldproducethelevelofoutputwheremarginalrevenueequalsmarginalcostProfitMaximizationTC=totalMarginalRevenuePriceequalsmarginalrevenueforaperfectlycompetitivefirmbecausethefirmdoesnothavetolowerthepricetosellmoreunitsofoutputTheprofit-maximizinglevelofoutputoccurswheremarginalrevenueequalsmarginalcostbecauseanyotherlevelofoutputwillresultinsmallerprofitMarginalRevenuePriceequalsmDeterminingtheAmountofProfitEarnedIfyouknowtotalrevenueandtotalcost,youcancalculateamountofprofitUsingTRandTCfunctiongraphs,youcancalculatelevelofprofit-maximizingbyfindingthegreatestdistancebetweenthetwocurvesandcalculatetheprofitatthatpointDeterminingtheAmountofProfTheShutdownPointTheshutdownpointforperfectlycompetitivefirm:theprice,whichjustequalsAVC,belowwhichitismoreprofitablefortheperfectlycompetitivefirmtoshutdownthantocontinuetoproduceThesupplycurveisthatportionofitsmarginalcostcurveaboveminimumAVCTheShutdownPointTheshutdownSupplyCurveforPerfectlyCompetitiveIndustryThesupplycurveshowstheoutputproducedbyallperfectlycompetitivefirmsintheindustryatdifferentpricesThecurvewillbeflatterthanthefirm’ssupplycurvebecauseitreflectsoutputproducedbyallfirmsintheindustryateachpriceSupplyCurveforPerfectlyComLong-runAdjustmentTwofactors:EntryandexitbynewandexistingfirmsChangesinthescaleofoperationsbyallfirmsThesefactorscanoccursimultaneouslyLong-runAdjustmentTwofactorLong-runAdjustmentEquilibriumpointfortheperfectlycompetitivefirm:thepointwherepriceequalsATCsincethefirmearnszeroeconomicprofitatthispointEconomicprofitincorporatesallimplicitcostsofproductionincludingnormalrateofreturnoninvestmentLong-runAdjustmentEquilibriuLong-runAdjustment:
EntryandExitFigure7.3Industry/MarketIndividualFirmD20PE2QE2QE1D1S1S2QE3PE1MCATCD1=P1=MR1P0Q1Q2ABD2=P2=MR2Long-runAdjustment:
EntryanLong-runAdjustmentFirmisaprice-taker;therefore,itmustacceptnewequilibriumpriceanddetermineappropriatelevelofoutputAllfirmsknowthepositiveeconomicprofitsOtherfirmsareabletoenterthemarketLong-runAdjustmentFirmisaOptimumScale
ofProductionLRACP1=MR1P2=MR2SMC1SATC1SMC2SATC2$0Q1Q2QFigure7.5OptimumScale
ofProductionLRAOptimumScale
ofProductionInFigure7.5,LRACincorporatesbotheconomiesofscaleanddiseconomiesofscaleLarge-scaleproductionwillgivemanagerscompetitiveedgebydecreasingproductioncostsCannotinfluencepriceofproductOptimumScale
ofProductionInManagershavelittleornocontroloverproductpriceTheycompeteonbasisofloweringcostsofproductionPerfectlycompetitivefirmsearnzeroeconomicprofitbecauseentryofotherfirmscompeteawayexcessprofitManagerialRuleofThumb:CompetitionMeansLittleControlOverPriceManagershavelittleornoconOtherCompetitiveMarketsIndustryconcentration:measureofhowmanyfirmsproducethet
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