The perfectly competitive markets

The Perfectly Competitive Market Economics 11 UPLB Market Economy    the market is a system where buyers and sellers exchange goods or services market is actually a very logical mechanism that helps answer the basic economic questions of what, how much and for whom to produce different commodities system continually allocates goods and services to various units with the help of a pricing mechanism The Market System    a market for commodities - rice, milk, water, coffee, clothes and many others a market for the inputs used in the production of these commodities like steel, minerals and labor Each market may have a different structure: the number of sellers or buyers  demand for the commodity  control in the market  Two General Types of Markets the Perfectly Competitive Market [5 main features] the imperfect market I II    Monopoly – one firm Oligopoly – two or more, but few firms Monopolistic competition – many firms selling differentiated products Features of Perfectly Competitive Market Smallness of buyers and sellers relative to the market Homogeneous product Absence of artificial restraints or controls Perfect mobility of goods and resources Perfect information The Demand Curve Faced by the Firm   since the firm cannot control the market price, owing to its smallness relative to the market, the firm can actually sell as much output as it wants without influencing the price the firm in perfect competition faces a perfectly elastic demand curve P d Q  the equilibrium price is still determined in the market by the forces of demand and supply Revenues of the Firm  Total revenue (TR) is the firm's gross income from the sale of its product TR=P.Q  Marginal revenue (MR) is the additional revenue earned from each additional unit of output sold MR=∆TR/∆Q  Average revenue (AR) is total revenue divided by output AR=TR/Q Market Firm Price D S P* d P* Q Equilibrium price is determined in the market Q Once determined, a firm can sell as much as it wants at that price Market Price Firm D2 D S P2 P2 d2 P* P* d Q Equilibrium price is determined in the market Q Once determined, a firm can sell as much as it wants at that price P P Price Price Supply P* P* Demand Q Output (A) Market Q Output (B) Firm FIGURE 6.1 The market and firm demand curves for a perfectly competitive good In the left panel of this diagram, we find a downward sloping market demand curve for the good Its intersection with the market supply curve determines the equilibrium price (P*) that will prevail in the market Since a perfectly competitive firm can sell all that it wants at P*, the firm’s demand curve is the horizontal line shown at the right panel of this diagram P D MC SAC P0 S1 LAC MR, AR P1 S0 P0 P1 Q1 Q0 At Po, firms are reaping profits New firms are attracted as long as profits are positive Supply curve shifts to the right, so price falls The entry or exit of firms will stop only when profit is reduced to zero This is at the lowest point of the LAC curve LMC COST LAC SMC1 SAC1 P MR, AR Q Long Run Equilibrium of the Industry: P = LMC = SMC, P = LAC = SAC Constant cost industry     Suppose that the industry’s initial long-run equilibrium corresponds to price and output levels P0 and Q0, respectively With an increase demand from D0 to D1 “short-run” equilibrium price and quantity increase The higher price makes the industry profitable Firms will be encouraged to enter the industry This causes a rightward shift in the market supply curve We have a constant cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price goes back to P0 P D0 D1 S0 S1 P1 P0 Price Long Run Supply Curve Q0 Q1 Quantity Q LMC COST LAC SMC1 P1 P0 SAC1 MR1 MR0 Q The increase in price will make the industry profitable This will result in entry of new firms The increased supply will drive the price down until profits are back to zero at P0 Increasing cost industry     Suppose that the industry’s initial long-run equilibrium corresponds to price and output levels P0 and Q0, respectively With an increase demand from D0 to D1 “short-run” equilibrium price and quantity increase The higher price makes the industry profitable Firms will be encouraged to enter the industry The entry of firms causes LAC to shift upwards We have a increasing cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price P1 is greater than P0 LMC COST LAC1 LAC0 P’1 SMC1 SAC1 P1 MR1 P0 MR0 Q0 Q1 Q The increase in price will make the industry profitable The entry of new firms causes the LAC to increase (move up) Equilibrium will be established at P1,Q1 P D0 D1 S0 S1 Long Run Supply Curve P’1 P1 P0 Price P’1 Q0 Q1 Quantity INCREASING COST INDUSTRY Q Decreasing cost industry  Industry’s initial long-run equilibrium corresponds to price and output levels P0 and Q0, respectively  An increase demand from D0 to D1 results in higher equilibrium price and quantity The higher price makes the industry profitable Firms will be encouraged to enter the industry However, the entry of firms causes LAC to shift downwards We have a decreasing cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price P1 is less than P0   COST LAC0 LAC1 SMC1 P’1 SAC1 MR1 P0 P1 MR0 Q1 Q0 Q The initial increase in price will make the industry profitable However, the entry of new firms will cause the LAC to decrease (shift downward) Equilibrium will be established at P1,Q1 P D0 D1 S0 S1 P’1 Price P0 P1 Long Run Supply Curve Q0 Q1 Quantity DECREASING COST INDUSTRY Q Letter from parents to son…    Dear Anak, Naipadala ko na 50 thousand pesos na tuition fee mo, pinagbili na namin ang mga kalabaw natin Ang mahal pala ng kursong COUNTER STRIKE, Wala na din pala tayong baboy naibenta na din para dun sa sinasabi mo na project nyo na NOKIA N75, ang mahal naman ng project nayun Kasama din ang thousand dun para sa field trip nyo sa MALL OF ASIA, anak malayo ba yun? mag ingat ka sa pagbibiyahe mo, Letter from parents to son…     Isasanla palang namin ang palayan natin para mabili mo na yung instrumentong I-POD na kinakailangan mo sa laboratory nyo Anak komportable kaba dyan sa boarding house mo san ba kamu yan sa VICTORIA COURT ??? maganda ba dyan? Presco ba hangin katulad dito sa atin? Anak kamusta na pala yung sayans group project nyo na SANMIG LIGHT? Napailaw nyo na ba? Mataas ba nakuha nyo na grado dun? Anak sana bago pa maubos ang lahat lahat ng ari arian natin ay makagradweyt ka na, walong taon ba talaga ang kurso mo sa SECRETARIAL? ?? Sanapag gradweyt mo makakuha ka ng trabaho kaagad kagaya ng manager ng kumpanyapara mabawi natin ang mga ari arian nating nasa sanglaan Letter from parents to son…  Ay sya nga pala anak diba sabi mo sa JOLLIBEE / MAK DONALD ka palagi kumakain ok ba naman sayo ang mga ulam dyan? Baka hindi masarap kawawa ka naman  Anak hanggang dito na lang at sa susunod ay ipapadala ko sayo ang pera na pambili mo ng ALTIS na gagamitin mo sa VACANT SUBJECT mo  Ang nagmamahal Itang at Inang P.S Anak mag aral ka ng mabuti Mahal na mahal ka namin at gagawin namin ang lahat alang-alang sa iyo [...]... production At P5 = min AVC, the loss is equal to the Total Fixed Cost (TFC), which is the also the loss if the firm did not produce Therefore the firm should shut down MC AC AVC t s o C dna eunev e R, eci r P loss P5 P5= MR5= AR5 0 Q5* Output Q Note that Q changes as P changes Given the P, Q is determined at P=MC There for the MC curve traces the firm’s supply curve, but only above the minimum AVC MC P1... for a perfectly competitive firm   The firm maximizes its profit at the intersection of the MR and MC curves (point A) This means that the firm’s profitmaximizing level of output is equal to Q* How large is the firm’s profit?    The firm’s total revenue is equal to the product of the price (line segment 0P*) and its output (line segment 0Q*) This suggests that its total revenue is equal to the area... Q1 Q Deriving profits from the TR and TC curves  Top panel    Profits or losses are measured by the vertical distance between the TR and TC curves For quantities between Q0 and Q1, the TR curve is above the TC curve For these levels of output, the firm’s profits are positive The TR and TC curves intersect at output levels Q0 and Q1 This means that the firm’s profits at these levels of output are... levels of output are zero since TR=TC For output levels to the left of Q0 and to the right of Q1, the TR curve is below the TC curve, which implies that the profits are negative Bottom Panel   a “bell-shaped” profit curve firm’s profits are highest at Q* where the slope of the TR curve (MR) and the slope of the TC curve (TC) are equal Hence, Q* is the firm’s profitmaximizing level of output MC 200 P*... total revenue is equal to the area 0P*AQ* On the other hand, the firm’s total cost is equal to the product of its average cost at Q* (line segment 0C) and its output (line segment 0Q*) This means that total cost is equal to the area 0CBQ* Since profit is equal to TR less TC, it is therefore equal to the difference between areas 0P*AQ* and 0CBQ* In other words, the firm’s profit is equal to CP*AB EFFECT... price makes the industry profitable Firms will be encouraged to enter the industry The entry of firms causes LAC to shift upwards We have a increasing cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price P1 is greater than P0 LMC COST LAC1 LAC0 P’1 SMC1 SAC1 P1 MR1 P0 0 MR0 Q0 Q1 Q The increase in price will make the industry profitable The entry of... increase The higher price makes the industry profitable Firms will be encouraged to enter the industry This causes a rightward shift in the market supply curve We have a constant cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price goes back to P0 P D0 D1 S0 S1 P1 P0 Price Long Run Supply Curve Q0 Q1 Quantity Q LMC COST LAC SMC1 P1 P0 0 SAC1 MR1 MR0 Q The. .. losses Loss Minimization at a price between the minimum AC and AVC curves     If the output price (such as P4) is between the minimum points of the AC and AVC curves, MR = MC at point A, and the best output level is equal to Q4 The firm is experiencing losses at P4 TR