University:
California State University, Northridge
Course:
ECON 500 | Survey of Economics
Academic year:

2024
Views:

301

Pages:

18
Author:

Amina Clayton

5 The Firm and the Industry Under Perfect Competition Part 1 Outline ● Types of Market Structure ● Perfect Competition Defined ● The Competitive Firm ● The Competitive Industry ● Perfect Competition and Economic Efficiency Types of Market Structure ● A market is a set of buyers and sellers whose behavior affects P at which a good is sold. ♦ E.g., Cisco stock sold in CA and WI is considered to take place in the same market, so markets don't necessarily refer to a geographical area. Types of Market Structure ● Economists describe different types of markets by: 1. the number of firms 2. whether the products of different firms are identical or different 3. how easy it is for new firms to enter the market Types of Market Structure ● The 4 major types of markets can be viewed on a continuum. Perfect Competition Monopolistic Competition (many small firms selling identical products) (many small firms producing slightly diff. products) Oligopoly (few large firms) Pure Monopoly (single firm) Perfect Competition Defined ● 4 conditions required for perfect competition: 1. Numerous small firms and customers –individual buyers and sellers do not impact P. 2. Homogeneity of product –products are identical. 3. Freedom of entry and exit –no barriers to enter, such as advertising costs or large sunk costs. Freedom to exit, so firms can leave the industry if it proves unprofitable. 4. Perfect information –each firm and customer is well informed about P. They know if 1 firm is selling at a lower P. Perfect Competition Defined ● These 4 conditions are rarely met. ♦ E.g., Ford stock –millions of buyers and sellers; shares are identical; entry into market is easy; and info about stock is available. Or fishing and farming. ● If perfect competition is so rare, then why study it? ♦ Standard by which all other markets are judged. ♦ Most efficient market because industry produces what society wants using scarce resources most effectively. ♦ Understand what an ideally functioning market can accomplish. See how far monopolist deviates. The Competitive Firm ● Firm is a P taker –it can produce as much or as little as it likes without affecting market P. ● Firm must match P offered by its competitors because products are identical. Otherwise, consumers shift their purchases to another firm. ● Industry, which is comprised of all the individual firms, can impact P through the forces of S and D. The Competitive Firm ● Firm’s D Curve under Perfect Competition: ● Horizontal demand ● Cannot impact market price ♦ E.g., Farmer Jones can double or triple Q and it has no effect on P corn. Jones is insignificant to the market exchange in Chicago, so she must accept P that a broker quotes her. FIGURE 1. Demand Curve for a Firm under Perfect Competition Price per Bushel in Chicago D $8 A B C E $8 Firm’s demand curve Industry supply curve S Industry demand curve S D 0 1 2 3 4 Truckloads of Corn Sold by Farmer Jones per Year (a) 0 100 200 300 400 Total Sales in Chicago in Thousands of Truckloads per Year (b) The Competitive Firm ● Short-Run Equilibrium for the Perfectly Competitive Firm: ♦ Profit-max Q is where MR = MC. ♦ D (or AR curve) is horizontal. So D is the MR curve or MR = P. ■ If a firm ↑Q by 1 unit, it still receives the same P. ♦ At an optimum Q: MR = P = MC → P = MC. TABLE 1. Revenues, Costs, and Profits of a Competitive Firm Quantity (1,000's of bushels) Total Revenue ($1,000's) Marginal Revenue ($1,000's) Total Cost ($1,000's) Marginal Cost ($1,000's) Total Profit ($1,000's) 0 0 ------ 0 ------ 0 10 80 80 85 85 -5 20 160 80 150 65 10 30 240 80 180 30 60 40 320 80 230 50 90 50 400 80 300 70 100 60 480 80 450 150 30 70 560 80 700 250 -140 Revenue and Cost per Bushel FIGURE 2. Short-Run Equilibrium of the Perfectly Competitive Firm MC $8 $6 AC B D = MR = AR = P A 4 0 50,000 Bushels of Corn per Year Short-Run Profit: Graphic Representation ● To measure profit graphically, compare height of D curve with height of AC curve. ● Recall: Profit = TR - TC TR = P x Q TC = AC x Q ● Since Q is identical, we can graphically compare P and AC to see if firm earns SR profits or losses. ● If P > AC → firm earns profits or if P < AC → firm incurs losses. Short-Run Profit: Graphic Representation ● Profit per unit = revenue per unit (P) - cost per unit (AC). If P > AC → firm makes a profit on each unit. ● E.g., AC = TC/Q = $300,000/50,000 = $6 and P = $8, so the profit per unit is $2 or vertical distance between points B and A in Fig. 2. ● Total profit = profit per unit (P-AC) x Q $100,000 = $2 x 50,000 = area labeled $8 $6 A B. ● MR = MC indicates profit-max Q but it doesn't show whether the firm earns profits or incurs losses. We must compare P and AC to determine this. Short-Run Losses: Graphic Representation ● If D is weak or costs are high, the firm’s most profitable option may lead to a loss. ● Assume P is $4 per bushel and relevant data in Table 2. ● Jones still produces Q at P = MR = MC to min. losses. ● Q = 30,000 where MR ≥ MC. ● Total loss is $5,000 = per unit loss (AC - P) of $0.167 x Q of 30,000. Losses are shown by area $4 $4.16 C D in Fig. 3 below. TABLE 2. Revenues, Costs, and Losses of a Competitive Firm Quantity (1,000's bushels) Total Revenue ($1,000's) Marginal Revenue ($1,000's) Total Cost ($1,000's) Marginal Cost ($1,000's) Total Profit ($1,000's) 0 0 ------ 45 ------ -45 10 40 40 65 20 -25 20 80 40 90 25 -10 30 120 40 125 35 -5 40 160 40 170 45 -10 50 200 40 220 50 -20 60 240 40 275 55 -35 70 280 40 335 60 -55 MC per Bushel Revenue and Cost FIGURE 3. Short-Run Equilibrium of Competitive Firm with Losses $4.16 4.00 0 AC C D D = MR = AR = P 30,000 Bushels of Corn per Year

The Firm and the Industry Under Perfect Competition, Part 1

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