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CHAPTER 12 Competition. Competition. What is perfect competition? How are price and output determined in a competitive industry? Why do firms enter and leave an industry? How do changes in demand and technology affect an industry? Why is perfect competition economically efficient?. - PowerPoint PPT Presentation
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CHAPTER 12Competition
Competition What is perfect competition? How are price and output determined
in a competitive industry? Why do firms enter and leave an
industry? How do changes in demand and
technology affect an industry? Why is perfect competition
economically efficient?
Perfect Competition Perfect competition arises when:
There are many firms, each selling an identical product.
There are many buyers. There are no restrictions on entry into
the industry. Firms in the industry have no advantage
over potential new entrants. Firms and buyers are completely
informed about other firms’ prices.
The Firm Has No Control Over the Price It Charges
Since each firm produces a small fraction of total industry output and the products are identical, no firm has any control over price.
Firms are price takers in perfectly competitive markets. A price taker is a firm that cannot influence the price of a good or service.
Elasticity of Industryand Firm Demand
A price taker firm faces a demand curve that is perfectly elastic (horizontal) because the product from firm A is a perfect substitute for the product from firm B.
However, the market demand curve will still slope downward; elasticity will be positive, but not infinite.
Competition inthe Real World
In reality, there are no markets that are absolutely perfectly competitive.
However, competition in some industries is so fierce that the model of perfect competition predicts extremely well how firms will behave.
Examples are computers, soft drinks, TVs, DVD players, potato chips, etc.
Economic Profit and Revenue Total revenue (TR)
Value of a firm’s sales TR = P Q
Marginal revenue (MR) Change in total revenue resulting from a one-
unit increase in quantity sold. MR = TR/ Q
Average revenue (AR) Total revenue divided by the quantity sold —
revenue per unit sold. AR = TR/Q = PxQ/Q = P
In perfect competition, Price = MR = AR
Economic Profit and Revenue
Suppose Cindy sells her sweaters in a perfectly competitive market.
What are Cindy’s TR, MR, and AR?
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25
9 25
10 25
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200
9 25
10 25
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200
9 25 225
10 25
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200
9 25 225
10 25 250
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 -
9 25 225
10 25 250
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 -
9 25 225 25
10 25 250
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 -
9 25 225 25
10 25 250 25
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 - 25
9 25 225 25
10 25 250 25
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 - 25
9 25 225 25 25
10 25 250 25
QTRMR /
Demand, Price, and Revenuein Perfect Competition
Quantity Price Marginal Average sold (P) Total revenue revenue (Q) (dollars revenue AR = TR/Q
(sweaters per TR = P ´ Q (dollars per (dollars per day) sweater) (dollars) additional sweater) per sweater)
8 25 200 - 25
9 25 225 25 25
10 25 250 25 25
QTRMR /
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousandsof sweaters per day)
Quantity (sweaters per day) Quantity (sweaters per day)
Pric
e (d
olla
rs p
er sw
eate
r)
Pric
e (d
olla
rs p
er sw
eate
r)
Tota
l rev
enue
(dol
lar
per
day)
0 9 20 0 10 20 0 9 20
25
50
25 225
50
Sweater Industry
Cindy’s demand,average revenue, andmarginal revenue
Cindy’s total revenue
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousandsof sweaters per day)
Quantity (sweaters per day) Quantity (sweaters per day)
Pric
e (d
olla
rs p
er sw
eate
r)
Pric
e (d
olla
rs p
er sw
eate
r)
Tota
l rev
enue
(dol
lar
per
day)
0 9 20 0 10 20 0 9 20
25
50
25 225
50
S
D
Sweater Industry
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousandsof sweaters per day)
Quantity (sweaters per day) Quantity (sweaters per day)
Pric
e (d
olla
rs p
er sw
eate
r)
Pric
e (d
olla
rs p
er sw
eate
r)
Tota
l rev
enue
(dol
lar
per
day)
0 9 20 0 10 20 0 9 20
25
50
25 225
50
S
D
AR=MR
Sweater Industry
Cindy’s demand,average revenue, andmarginal revenue
Cindy’sdemandcurve
Demand, Price, and Revenue
in Perfect Competition
Quantity (thousandsof sweaters per day)
Quantity (sweaters per day) Quantity (sweaters per day)
Pric
e (d
olla
rs p
er sw
eate
r)
Pric
e (d
olla
rs p
er sw
eate
r)
Tota
l rev
enue
(dol
lar
per
day)
0 9 20 0 10 20 0 9 20
25
50
25 225
50
S
D
AR=MR
TR
a
Sweater Industry
Cindy’s demand,average revenue, andmarginal revenue
Cindy’s total revenue
Cindy’sdemandcurve
Economic Profit and Revenue
The firm’s goal is to maximize economic profit.
Total cost is the opportunity cost — including normal profit.
The Firm’s Decisions inPerfect Competition
A firm’s task is to make the maximum economic profit possible, given the constraints it faces.
In order to do so, the firm must make two decisions in the short-run, and two in the long-run.
The Firm’s Decisions inPerfect Competition
Short-run A time frame in which each firm has a
given plant and the number of firms in the industry is fixed
Long run A time frame in which each firm can
change the size of its plant and decide whether to leave or stay in the industry.
The Firm’s Decisions inPerfect Competition
In the short-run, the firm must decide:
Whether to produce or to shut down.
If the decision is to produce, what quantity to produce.
Price is not a decision because firm is a price taker.
The Firm’s Decisions inPerfect Competition
In the long-run, the firm must decide: Whether to increase of decrease its
plant size Whether to stay in the industry or leave
itWe will first address the short-
run.
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 221 25 452 50 663 75 854 100 1005 125 1146 150 1267 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 452 50 663 75 854 100 1005 125 1146 150 1267 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 663 75 854 100 1005 125 1146 150 1267 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 854 100 1005 125 1146 150 1267 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 1005 125 1146 150 1267 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 1146 150 1267 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 1267 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 1418 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 1609 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 160 409 225 18310 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 160 409 225 183 4210 250 21011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 160 409 225 183 4210 250 210 4011 275 24512 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 160 409 225 183 4210 250 210 4011 275 245 3012 300 30013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 160 409 225 183 4210 250 210 4011 275 245 3012 300 300 013 325 360
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 160 409 225 183 4210 250 210 4011 275 245 3012 300 300 013 325 360 -35
Total Revenue, Total Cost,and Economic Profit
Quantity Total Total Economic (Q) revenue cost profit (sweaters (TR) (TC) (TR – TC)
Per day) (dollars) (dollars) (dollars)
0 0 22 -221 25 45 -202 50 66 -163 75 85 -104 100 100 05 125 114 116 150 126 247 175 141 348 200 160 409 225 183 4210 250 210 4011 275 245 3012 300 300 013 325 360 -35
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
Tota
l rev
enue
& to
tal c
ost
(dol
lars
per
day
)
0 4 9 12
100
300
183
225
Revenueand Cost
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
Tota
l rev
enue
& to
tal c
ost
(dol
lars
per
day
)
0 4 9 12
100
300
183
TR
225
Revenueand Cost
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
Tota
l rev
enue
& to
tal c
ost
(dol
lars
per
day
)
0 4 9 12
100
300
183
TRTC
225
Revenueand Cost
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
Tota
l rev
enue
& to
tal c
ost
(dol
lars
per
day
)
0 4 9 12
100
300
183
225
TRTC
Economicloss
Economicprofit =TR - TC
Revenueand Cost
Total Revenue, Total Cost,and Economic Profit
4 9 12-20
0
-40
42
20
Quantity (sweaters per day)Profit/
loss
Prof
it/lo
ss (d
olla
rs p
er d
ay)
Economic profit/loss
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
4 9 12-20
0
-40
42
20
Profitmaximizing quantity
Profit/loss
Economicprofit
Economicloss
Prof
it/lo
ss (d
olla
rs p
er d
ay)
Economic profit/loss
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
4 9 12-20
0
-40
42
20
Profitmaximizing quantity
Profit/loss
Prof
it/lo
ss (d
olla
rs p
er d
ay) MR>MC MR<MCMR=MC
Break-even Output An output at which total cost equals
total revenue is called a break-even point.
Even though economic profit is zero at break-even output, the firm still earns a normal profit.
Remember, normal profit is part of total (opportunity) cost.
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
Tota
l rev
enue
& to
tal c
ost
(dol
lars
per
day
)
0 4 9 12
100
300
183
225
TRTC
Breakeven Points
Total Revenue, Total Cost,and Economic Profit
Quantity (sweaters per day)
4 9 12-20
0
-40
42
20
Profitmaximizing quantity
Prof
it/lo
ss (d
olla
rs p
er d
ay) Breakeven Point Breakeven Point
Profit/loss
Marginal Analysis Using marginal analysis, a
comparison is made between a units marginal revenue and marginal cost.
Marginal Analysis If MR > MC, the extra revenue from selling
one more unit exceeds the extra cost. The firm should increase output to increase
profit If MR < MC, the extra revenue from selling
one more unit is less than the extra cost. The firm should decrease output to increase
profit If MR = MC economic profit is maximized.
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
- -
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
- -25
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-19
-25
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-19
-2525
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-1923
-2525
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-1923
-252525
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-192327
-252525
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-192327
-25252525
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-19232735
-25252525
Profit-Maximizing Output Marginal Marginal revenue cost
Quantity Total (MR) Total (MC) Economic(Q) revenue (dollars per cost (dollars per
profit(sweaters (TR) additional (TC) additional
(TR – TC)per day) (dollars)sweater) (dollars sweater) (dollars)
7 175 141 34 8 200 160 40 9 225 183 4210 250 210 4011 275 245 30
-19232735
-25252525
Profit-Maximizing Output
Quantity (sweaters per day) 8 9 10
10
20
30
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)
25
Profit-Maximizing Output
Quantity (sweaters per day) 8 9 10
10
20
30
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)
MR = AR = P25
Profit-Maximizing Output
Quantity (sweaters per day) 8 9 10
10
20
30
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)
MR = AR = P25
MC
Profit-Maximizing Output
Quantity (sweaters per day) 8 9 10
10
20
30
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)
MR = AR = P25
MCProfit-maximizationpoint
Loss from10th sweater
Profit from9th sweater
Economic Profitin the Short Run
Maximizing economic profit does not guarantee that profits will be positive.
Economic profit can be positive, negative or zero.
To calculate total profit, we must subtract total cost from total revenue.
Price, Average Total Cost, and Profit
Price is total revenue per unit, or average revenue (P=AR=TR/Q)
Average total cost is total cost per unit (ATC=TC/Q).
Profit = TR - TC Profit per unit=(TR-TC)/Q=TR/Q-TC/Q = (P - ATC) That means we can calculate total
profit as (P - ATC)xQ.
Profits and Losses in the Short-Run
As we indicated, at short-run equilibrium firms may: Earn a profit Break even Incur an economic loss.
Profits and Losses in the Short-Run
If price equals average total cost (P=ATC), a firm breaks even.
If price exceeds average total cost (P>ATC), a firm makes an economic profit.
If price is less than average total cost (P<ATC), a firm incurs an economic loss.
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
15.00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
8 10
30.00MC ATC
Possible Outcome OneP=ATC
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
15.00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
8 10
30.00
AR = MR = P
MC ATCBreak-evenpoint
Possible Outcome OneP=ATCProfits=(P-ATC)xQ=(20-20)x8 = 0
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
15.00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
8 10
30.00MC ATC
Possible Outcome Two
P>ATC
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
15.00
20.33
25.00
Three Possible Profit Outcomes in the Short-Run
9 10
30.00
AR = MR = P
MC ATCPossible
Outcome TwoP>ATC
Profits=(P-ATC)xQ=(25-20.33)x9=4.67x9=42
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
15.00
20.33
25.00
Three Possible Profit Outcomes in the Short-Run
9 10
30.00
AR = MR = P
MC ATCPossible
Outcome TwoP>ATC
Profits=(P-ATC)xQ=(25-20.33)x9=4.67x9=42
Economic Profit
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
15.00
20.00
25.00
Three Possible Profit Outcomes in the Short-Run
9 10
30.00MC ATC
Possible Outcome Three
P<ATC
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
17.00
20.14
25.00
Three Possible Profit Outcomes in the Short-Run
30.00MC ATC
Possible Outcome Three
P<ATC
AR = MR = P
7 10
Profits=(P-ATC)xQ=(17-20.14)x7=-22
Quantity (millions of chips per year)
Pric
e (d
olla
rs p
er c
hip)
17.00
20.14
25.00
Three Possible Profit Outcomes in the Short-Run
30.00MC ATC
Possible Outcome Three
P<ATC
AR = MR = P
7 10
Profits=(P-ATC)xQ=(17-20.14)x7=-22Economic Loss
Three Possible Profit Outcomes in the Short-run
The Firm’s Short-Run Supply Curve
Fixed costs must be paid in the short-run.
Variable-costs can be avoided by laying off workers and shutting down.
Firms shut down if price falls below the minimum of average variable cost.
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)
AVC
ATC
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)MC
AVC
ATC
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)MC
MR1=P1=25
AVC
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)MC
MR2=P2=31
AVC
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)MC
MR0=P0=17
AVC
s
Shutdown point
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)MC = Supply
AVC
s
MR1=P1=25
MR2=P2=31
MR0=P0=17
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)S = MC
sAVC
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)S = MC
sAVC
A Firm’s Supply Curve
Quantity (sweaters per day)7 9 10
17
25
31
Mar
gina
l rev
enue
& m
argi
nal c
ost
(dol
lars
per
day
)S = MC
s
The Firm’s Short-Run Supply Curve
A perfectly competitive firm’s short-run supply curve shows how its profit-maximizing output varies as market price changes.
Since price must equal marginal cost, the marginal cost curve is also the supply curve.
However, only the portion of the marginal cost curve above the minimum average variable cost curve is relevant.
Temporary Plant Shutdown A firm cannot avoid incurring its fixed
costs but it can avoid variable costs. A firm that shuts down and produces no
output incurs a loss equal to its total fixed cost.
A firm’s shutdown point is the level of output and price where the firm is just covering its total variable cost.
In other words, if its losses are bigger than its fixed costs, the firm will shut down.
Production Decisions When price is below the minimum
point of the AVC curve, the firm will shut down and supply zero output.
When price is above the lowest point of the AVC curve, the firm will produce the level of output where price equals marginal cost.
The short-run supply curve is therefore the MC curve above the AVC curve.
Output, Price, and Profitin the Long Run
In short-run equilibrium, a firm might make an economic profit, incur an economic loss, or break even (make a normal profit). Only one of these situations is a long-run equilibrium.
In the long run either the number of firms in an industry changes or firms change the scale of their plants.
Economic Profit and Economic Loss as Signals
If an industry is earning above normal profits (positive economic profits), firms will enter the industry and begin producing output.
This will shift the industry supply curve out, lowering price and profit.
Economic Loss as a Signal If an industry is earning below
normal profits (negative economic profits), some of the weaker firms will leave the industry.
This shifts the industry supply curve in, raising price and profit.
Long-Run Adjustments Forces in a competitive industry
ensure only one of these situations is possible in the long-run.
Competitive industries adjust in two ways: Entry and exit Changes in plant size
Entry and Exit The prospect of persistent profit or
loss causes firms to enter or exit an industry.
If firms are making economic profits, other firms enter the industry.
If firms are making economic losses, some of the existing firms exit the industry.
Entry and Exit This entry and exit of firms influence
price, quantity, and economic profit.
Let’s investigate the effects of firms entering or exiting an
industry.
S1
Entry
Quantity (thousands of sweaters per day)6 7 8 9 10
Pric
e (d
olla
rs p
er sw
eate
r)
D1
23
17
20
Entry
Quantity (thousands of sweaters per day)6 7 8 9 10
Pric
e (d
olla
rs p
er sw
eate
r)
S1 S0
23
17
20
D1
Exit
Quantity (thousands of sweaters per day)6 7 8 9 10
Pric
e (d
olla
rs p
er sw
eate
r)
D1
23
17
20
S2
Exit
Quantity (thousands of sweaters per day)6 7 8 9 10
Pric
e (d
olla
rs p
er sw
eate
r)
S0
23
17
20
D1
S2
Entry and Exit
Quantity (thousands of sweaters per day)6 7 8 9 10
Pric
e (d
olla
rs p
er sw
eate
r)
S0
23
17
20
D1
S2S1
Entry and ExitImportant Points
As new firms enter an industry, the price falls and the economic profit of each existing firm decreases.
As firms leave an industry, the price rises and the economic loss of each remaining firm decreases.
Long-Run Equilibrium Long-run equilibrium occurs in a
competitive industry when firms are earning normal profit and economic profit is zero.
Economic profits draw in firms and cause existing firms to expand.
Economic losses cause firms to leave and cause existing firms to scale back.
Long-Run Equilibrium So in long-run equilibrium in a
competitive industry, firms neither enter nor exit the industry and firms neither expand their scale of operation nor downsize.
Long-Run Equilibrium In long-run equilibrium, firms will be
earning only a normal profit. Economic profits will be zero.
Firms will neither enter nor exit the industry.
In long run equilibrium, P=MC and P=ATC. Thus, P=MC=ATC.
Because MC=ATC, ATC must be at its minimum.
Changing Tastes and Advancing Technology
What happens in a competitive industry when a permanent change in demand occurs?
A Decrease in Demand
Quantity
Pric
e
0 Quantity
Pric
e an
d C
ost
Industry Firm
A Decrease in Demand
Quantity
Pric
e
0
P0
Quantity
Pric
e an
d C
ost
P0
q0
D0
MR0
S0MC
ATC
Industry Firm
Q0
A Decrease in Demand
Quantity
Pric
e
0
P0
Quantity
Pric
e an
d C
ost
P0
q0
D0
MR0
S0MC
ATC
Industry Firm
D1
P1MR1
q1Q0Q1
P1
A Decrease in Demand
Quantity
Pric
e
0 Quantity
Pric
e an
d C
ostS0
MC
ATC
Industry Firm
D1
P1MR1
q1Q1
P1
A Decrease in Demand
Quantity
Pric
e
0
P0
Quantity
Pric
e an
d C
ost
P0
q0
MR0
S0MC
ATC
Industry Firm
D1
P1MR1
q1Q1
S1
Q2
P1
A Decrease in Demand
Quantity
Pric
e
0
P0
Quantity
Pric
e an
d C
ost
P0
q0
MR0
S0MC
ATC
Industry Firm
D1
MR1
S1
Q2
A Decrease in Demand
Quantity
Pric
e
0
P0
Quantity
Pric
e an
d C
ost
P0
q0
D0
MR0
S0MC
ATC
Industry Firm
D1
P1MR1
q1Q0Q1
S1
Q2
Summary
P1
Changing Tastes and Advancing Technology
Technological change New technology allows firms to produce
at lower costs.• This causes their cost curves to shift downward.
Firms adopting the new technology make an economic profit.• This draws in new technology firms
Old technology firms disappear, the price falls, and the quantity produced increases.
Changing Tastes and Advancing Technology
A competitive industry is rarely in a long-run equilibrium.
What happens in a competitive industry when there is a permanent increase or decrease in the demand for its product?
What happens in a competitive industry when technological change lowers its production costs?
A Permanent Changein Demand
A permanent decrease in demand will cause the short-run equilibrium price and quantity to fall.
In the long run, firms will leave the industry (because economic profits are negative), raising price enough to restore a normal level of profit.
The difference is the number of firms in the industry.
A Permanent Increasein Demand
The increase in demand causes industry price and profits to rise.
Firms enter the industry, increasing market supply and eventually lowering price to its original level.
However there are now more firms in the industry.
Technological Change Technological improvements lower
average cost of production. Most technological improvements
cannot be implemented without investment in new plant and equipment.
This means it takes time for a technological advance to spread through an industry.
Technological Change and Equilibrium Price
A technological improvement that affects all firms will shift the industry supply curve down and to the right.
Firms now earn economic profits and new firms enter the industry.
This this drives down equilibrium price and raises industry output.
Technological Change and Equilibrium Profit
Implementing a technological improvement causes the marginal cost curve for each firm to shift down and to the right.
Economic profits are not affected in the long run.
The firms that survive in the long run are those that adopted the new technology early.