Slide Set 6: Market Equilibrium & Perfect Competition

Transcription

1 Economics 10 Slide Set 6: Market Equilibrium & Perfect Competition University of North Carolina Chapel Hill Structure of Perfect Competition Structural Assumptions Large number of small buyers and seller. Homogeneous product Free entry and exit Perfect information Behavioral Assumption Independent actions by buyers and sellers What are the practical implications of these assumptions? How many different prices can there be in one perfectly competitive market. How much influence does each individual firm's choice have on the market price? A Step Back A firm is assumed to choose to produce a quantity that maximizes its profits given it is constrained by technology and must purchase inputs given it must find willing buyers The cost function summarizes the technological and input market constraints The FIRM'S demand curve summarize the output market constraint MR = MC defines the profit maximizing condition What defines the firm's demand curve and thus it marginal revenue curve? Econ 10 (6) Perfect Competition_p.PRZ 1-3 JF Stewart, Econ 10 01/28/05

2 $/truckload Demand Curve for a Perfectly Competitive FIRM Farm Brown's Demand Curve truckloads of wheat Q P TR MR The demand curve of a perfectly competitive firm will be a horizontal line at the current market price The firm's demand curve and its marginal revenue curve are the same in perfect competition P=MR The demand curve of a perfectly competitive firm will be infinitely elastic Output Decision of a Perfectly Competitive Firm Profit Maximization in the $/truckload MC AC Farm Brown's Demand Curve truckloads of wheat Shutdown and Break-even Analysis Produce at P = MC or produce nothing at all? Rule 1. The firm will make a profit if total revenue exceeds total cost. It should not plan to shut down either in the short run or in the long run. Rule 2. The firm should continue to operate In the short run if total revenue exceeds total short run variable cost (P > ) In the long run, a competitive firm will shut down if total revenue is less than total cost. Econ 10 (6) Perfect Competition_p.PRZ 4-6 JF Stewart, Econ 10 01/28/05

3 Costs Supply Decision of a Perfectly Competitive firm, If P mrkt is the price, how much should the firm produce to maximize profits? Costs Supply Decision of a Perfectly Competitive firm, How much output will the firm choose to produce at P MRKT? Will the firm be making a profit or a loss On the graph show the size of the profits the firm will make if price = P MRKT. Costs Supply Decision of a Perfectly Competitive firm, How much output will the firm choose to produce at P MRKT? Will the firm be making a profit or a loss On the graph show the size of the profits the firm will make if price = P MRKT. If the firm choose to produce zero units of output instead of choosing the point where P MRKT = MC, how much bigger or smaller would its profits be? Econ 10 (6) Perfect Competition_p.PRZ 7-9 JF Stewart, Econ 10 01/28/05

4 Costs Supply Curve of Competitive Firm For any price above the point where crosses the curve, Firm Supply Curve The is the FIRM'S SUPPLY CURVE Output Decision of a Perfectly Competitive Firm Profit Maximization in the If the price of the good is P MRKT how much will Brown decide to produce? Smith decide to produce? What is the total quantity supplies at the market price? If one firm maximizes profit at P = MC so do others. We can add up the output decision of all firms to get the market supply curve Brown Smith Market (all firms) $ $ $ MC MC Market Supply B S (sum of firms 's) 5 9 QB QS Qmrkt Competitive Equilibrium Notion of Equilibrium & Conditions IF AT THE GIVEN PRICE, THE AMOUNT THE CONSUMERS ARE WILLING TO PURCHASE IS NOT THE SAME AS THE AMOUNT FIRMS ARE WILLING TO SELL, SOMETHING HAS GOT TO GIVE. That something is the market price For each Firm P =(Q) (If P > ) (they want to max. profits) In the Market P must be such that Quant.. Demanded = Quant. Supplied. Econ 10 (6) Perfect Competition_p.PRZ JF Stewart, Econ 10 01/28/05

5 Competitive Equilibrium The Graph If this is a competitive market in the short run, how much output will the typical firm produce? what will be the total amount produced in the market? what will be the market price? how much profits/losses with the typical firm be making? $ $ Market (all firms) SUPPLYMRKT SRAC qfirm Qmrkt Competitive Market Equilibrium Long Run Adjustment Show on the graph how much profits the typical firm is making? As firms enter, which curve will shift and in what direction? What will happen to market price as firms enter? Total Market $ $ MC Market Demand Supply (100 firms) AC 5 Qfirm 500 QMarket Competitive Market Equilibrium Long Run Adjustment If firms will enter so long as profits are greater than zero. What will happen to the supply curve if profits >0? How will this effect market price? where does the process logically have to end? Total Market $ $ MC Market Demand Supply (100 firms) AC 4 5 Qfirm QMarket Econ 10 (6) Perfect Competition_p.PRZ JF Stewart, Econ 10 01/28/05

6 What conditions must hold when a perfectly competitive market is in Long Run Equilibrium? Long Run Competitive Equilibrium Supplied = Demanded (It has to or it must adjust) Price = Marginal Cost = Average Cost P = MC because firms choose that to maximize profits MR=MC, profit max rule P=MR for a competitive firm P= AC because free entry drives economic profits to zero Econ 10 (6) Perfect Competition_p.PRZ JF Stewart, Econ 10 01/28/05