Perfect Competition: F Q Y Q K T & A S

Perfect
Competition
PREPARED BY:
FERNANDO QUIJANO, YVONN QUIJANO,

KYLE THIEL & APARNA SUBRAMANIAN
2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, OSullivan Sheffrin Perez
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1 What is the break-even price?

The Break-Even Price for a Corn Farmer
2 How do entry costs affect the number of firms in a market?
Wireless Women in Pakistan
3 How do producers respond to an increase in price?
Wolfram Miners Obey the Law of Supply
4 When production costs vary across producers, what are the implications for
the market supply curve?
The Worldwide Supply of Sugar
5 When input prices increase with the total output of the industry, what are the
implications for the market supply curve?
Zoning, Land Prices, and the Supply Curve for Apartments
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PERFECT COMPETITION
perfectly competitive market
A market with many sellers and
buyers of a homogeneous product
and no barriers to entry.
price taker
A buyer or seller that takes the
market price as given.
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PERFECT COMPETITION
Here are the five features of a perfectly competitive

market:
1 There are many sellers.
2 There are many buyers.
3 The product is homogeneous.
4 There are no barriers to market entry.
5 Both buyers and sellers are price takers.
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Extra Application 6
COFFEE WARS
Starbucks, the current heavyweight of the upscale coffee world with 8,600 stores, is being
challenged by Dunkin Donuts. The doughnut chain currently maintains 4,400 stores but
plans to open 10,000 more outlets by 2020.
Many of the upscale coffee houses, and their patrons, do not view Dunkin Donuts as
competition.
Others indicated they prefer Dunkin Donuts coffee over Starbucks.
The new Dunkin Donuts outlets have a new imagemore urban and upscale.
Can this market accommodate a new entrant?
It is my belief that consumers buy the coffee and the
atmosphere of the coffee house. Starbucks will view
Dunkin Donuts as a competitive threat if the company
believes they appeal to the same market. New entrants will
push the supply curve to the right and result in a lower
price. However, I believe Starbucks will attempt to reinforce
its image as the upscale coffee house where higher income
individuals should be seen. If this is the case, then the
market is actually for coffee houses, and not coffee.
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6.1
PREVIEW OF THE FOUR MARKET STRUCTURES
firm-specific demand curve

A curve showing the relationship
between the price charged by a
specific firm and the quantity the
firm can sell.
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6.1
FIGURE 6.1
Monopoly Versus Perfect Competition
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6.1
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6.2
THE FIRMS SHORT-RUN OUTPUT DECISION
The Total Approach: Computing Total Revenue and Total

Cost
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6.2
The Total Approach: Computing Total Revenue and Total

Cost
FIGURE 6.2
Using the Total Approach to
Choose an Output Level
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6.2
The Marginal Approach
marginal revenue
The change in total revenue from
selling one more unit of output.
marginal revenue = price
To maximize profit, produce the quantity where price = marginal cost
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6.2
The Marginal Approach

FIGURE 6.3
The Marginal Approach to Picking an Output Level
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6.2
Economic Profit and the Break-Even Price

economic profit = (price average cost) quantity produced
break-even price
The price at which economic profit is
zero; price equals average total cost.
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6.3
THE FIRMS SHUT-DOWN DECISION
Total Revenue, Variable Cost, and the Shut-Down Decision
operate if total revenue > variable cost

shut down if total revenue < variable cost
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6.3
Total Revenue, Variable Cost, and the Shut-Down

Decision
FIGURE 6.4
The Shut-Down Decision and
the Shut-Down Price
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6.3
The Shut-Down Price

operate if price > average variable cost
shut down if price < average variable cost
shut-down price
The price at which the firm is
indifferent between operating and
shutting down; equal to the minimum
average variable cost.
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6.3
Fixed Costs and Sunk Costs

sunk cost
A cost that a firm has already paid or
committed to pay, so it cannot be
recovered.
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THE BREAK-EVEN PRICE FOR A CORN FARMER

APPLYING THE CONCEPTS #1: What is the break-even price?
To illustrate the notions of break-even and shut-down

prices, lets look at these prices for the typical corn farmer.
The break-even, or zero-profit, price is $0.72 per bushel.
At this price, the farmer will produce at the minimum point of the average total-cost
curve, with the average cost equal to the market price of $0.72.
At a higher price, the farmer will make a positive economic profit.
The corn farmers shut-down price is $0.44.
At a price between the shut-down price ($0.44) and the break-even price ($0.72),
the farmer will lose money but will continue to operate at a loss because total
revenue will exceed the variable cost of growing corn.
In the long run, farmers will exit the market if the price stays below the break-even
price of $0.72.
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6.4
SHORT-RUN SUPPLY CURVES
The Firms Short-Run Supply Curve

short-run supply curve
between the market price of a
product and the quantity of output
supplied by a firm in the short run.
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6.4
The Firms Short-Run Supply Curve

FIGURE 6.5
Short-Run Supply Curves
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6.4
The Short-Run Market Supply Curve

short-run market supply curve
between market price and the
quantity supplied in the short run.
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6.4
Market Equilibrium
FIGURE 6.6
Market Equilibrium
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6.4
Market Equilibrium
For a short-run equilibrium, two conditions are satisfied:
1 At the market level, the quantity of the product supplied equals the
quantity demanded. The demand curve intersects the short-run market
supply curve at a price of $7 and a quantity of 600 shirts per minute
(Panel A).
2 The typical firm in the market maximizes its profit, given the market
price. Given the market price of $7, each of the 100 firms maximizes
profit by producing 6 shirts per minute (Panel B).
The market reaches a long-run equilibrium when the two conditions for
short-run equilibrium are met, and a third long-run condition holds as well.
3 Each firm in the market earns zero economic profit, so there is no
incentive for existing firms to leave the market and no incentive for other
firms to enter the market.
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WIRELESS WOMEN IN PAKISTAN
APPLYING THE CONCEPTS #2: How do entry costs affect the number
of firms in a market?
In Pakistan, many poor villagers cannot afford their own

phones, and phone service is provided by thousands of
wireless women, entrepreneurs who invest $310 in wireless
phone equipment (transceiver, battery, charger), a signboard,
a calculator, and a stopwatch.
They sell phone service to their neighbors, charging by the minute and second.
On average, their net income is about $2 per day, about three times the average
per capita income in Pakistan.
The market for phone service has the features of a perfectly competitive market, with
easy entry, a standardized good, and a large enough number of suppliers that each
takes the market price as given.
In contrast, to enter the phone business in the United States, your initial investment
would be millions, or perhaps billions, of dollars, so the market for phone service is
not perfectly competitive.
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6.5
THE LONG-RUN SUPPLY CURVE FOR AN

INCREASING-COST INDUSTRY
long-run market supply curve
between the market price and
quantity supplied in the long run.
increasing-cost industry
An industry in which the average
cost of production increases as the
total output of the industry increases;
the long-run supply curve is
positively sloped.
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Extra Application 7
ORACLES QUEST FOR GREATER EFFICIENCY
Oracle Corporations recent takeover of rival Siebel Systems Inc. has spurred substantial
job cuts. Oracle is expected to cut between 1,000 and 2,000 jobs that are primarily in
functional areas that represent duplication of efforts. Oracle currently employs 51,000
original Oracle employees and the additional 4,700 Siebel employees.
The reduction in work force could cost some Oracle employees their jobs as the
company attempts to boost profits via the downsizing.
The companys cost-cutting moves are an attempt to compete with rival SAP in
business application software.
Shareholders are not overly impressed with Oracle stock closing only 20 cents a
share higher after the announcement.
Oracle Corporations acquisition of Siebel has allowed the
software firm to reduce average total costs via reduction in
labor force. Many jobs in the now-merged company had
substantial overlap and Oracle can reduce costs by
eliminating duplicate positions. Oracles total output will be
higher but the long-run average cost per unit should
decline. Oracle will benefit from additional economies of
scale as production and costs move from point a to point b.
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6.5

The average cost increases as the industry grows for two reasons:
1
Increasing input price. As an industry grows, it competes with

other industries for limited amounts of various inputs, and this
competition drives up the prices of these inputs.
Less productive inputs. A small industry will use only the most
productive inputs, but as the industry grows, firms may be forced to
use less productive inputs.
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6.5

Production Cost and Industry Size
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6.5

Drawing the Long-Run Market Supply Curve

FIGURE 6.7
Long-Run Market Supply Curve
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WOLFRAM MINERS OBEY THE LAW OF SUPPLY

APPLYING THE CONCEPTS #3: How do producers respond to an
increase in price?
Consider the market for wolfram during World War II. Wolfram is an ore of tungsten,
an alloy required to make heat-resistant steel for armor plate and armor-piercing
shells. During World War II, the United States and its European allies bought up all
the wolfram produced in Spain, thus denying the Axis powersGermany and Italy
this vital military input. However, the wolfram-buying program was very costly to
the Allied powers for two reasons:
The Allied powers had to outbid the Axis powers for the wolfram, so the price
increased from $1,144 per ton to $20,000 per ton.
Spanish firms responded to the higher prices by supplying more wolfram.
Workers poured into the Galatia area in Spain, where they used simple tools to
gather wolfram from the widely scattered outcroppings of ore. Because of this
market entry, the quantity of wolfram supplied increased tenfold. Because
wolfram miners obeyed the law of supply, the Allied powers were forced to buy
a huge amount of wolfram, much more than they had expected.
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THE WORLDWIDE SUPPLY OF SUGAR

APPLYING THE CONCEPTS #4: When production costs vary across
producers, what are the implications for the market supply curve?
The sugar industry is another example of an increasing-cost industry.

If the price of sugar is only 11 cents per pound, sugar production is
profitable in areas with relatively low production costs, including the
Caribbean, Latin America, Australia, and South Africa.
At a price of 11 cents, the world supply of sugar equals the amount
produced in these areas.
As the price increases, sugar production becomes profitable in areas
where production costs are higher, and as these areas enter the world
market, the quantity of sugar supplied increases.
At a price of 24 cents, production is profitable even in the United
States.
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6.6
SHORT-RUN AND LONG-RUN EFFECTS

OF CHANGES IN DEMAND
The Short-Run Response to an Increase in Demand

FIGURE 6.8
Short-Run Effects of an Increase in Demand
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6.6
SHORT-RUN AND LONG-RUN EFFECTS

OF CHANGES IN DEMAND
The Long-Run Response to an Increase in Demand
FIGURE 6.9
Short-Run and Long-Run Effects
of an Increase in Demand
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ZONING, LAND PRICES, AND THE SUPPLY CURVE FOR

APARTMENTS
APPLYING THE CONCEPTS #5: When input prices increase with
the total output of the industry, what are the implications for the
market supply curve?
In many communities, the rental-apartment industry is an

increasing-cost industry. As the industry expands by building
more apartments, competition is fierce among firms for the small
amount of land zoned for apartments.
What are the implications of zoning for a market that experiences an increase in
demand?
In the short run, the stock of housing is fixed. An increase in demand for
apartments will increase the price of apartments (the monthly rent), and firms will
convert some owner-occupied houses to rental apartments.
In the long run, firms will enter the market by building more apartments. The
increase in demand leads to a net increase in price because zoning restricts the
supply of apartment land, leading to higher land prices and a higher cost of
producing apartments.
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6.7
LONG-RUN SUPPLY FOR A

CONSTANT-COST INDUSTRY
constant-cost industry
An industry in which the average cost
of production is constant; the longrun supply curve is horizontal.
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6.7

Long-Run Supply Curve for a Constant-Cost Industry

FIGURE 6.10
Long-Run Supply Curve for a
Constant-Cost Industry
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6.7

Hurricane Andrew and the Price of Ice

FIGURE 6.11
Hurricane Andrew and the
Price of Ice
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break-even price
perfectly competitive market
constant-cost industry
price taker
firm-specific demand curve
short-run supply curve
increasing-cost industry
short-run market supply curve
long-run market supply curve
shut-down price
marginal revenue
sunk cost

Perfect Competition: F Q Y Q K T & A S

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Perfect

FERNANDO QUIJANO, YVONN QUIJANO,

1 What is the break-even price?

Here are the five features of a perfectly competitive

PREVIEW OF THE FOUR MARKET STRUCTURES

firm-specific demand curve

PREVIEW OF THE FOUR MARKET STRUCTURES

PREVIEW OF THE FOUR MARKET STRUCTURES

THE FIRMS SHORT-RUN OUTPUT DECISION

The Total Approach: Computing Total Revenue and Total

THE FIRMS SHORT-RUN OUTPUT DECISION

The Total Approach: Computing Total Revenue and Total

THE FIRMS SHORT-RUN OUTPUT DECISION

The Marginal Approach

THE FIRMS SHORT-RUN OUTPUT DECISION

The Marginal Approach

THE FIRMS SHORT-RUN OUTPUT DECISION

Economic Profit and the Break-Even Price

THE FIRMS SHUT-DOWN DECISION

Total Revenue, Variable Cost, and the Shut-Down Decision

operate if total revenue > variable cost

THE FIRMS SHUT-DOWN DECISION

Total Revenue, Variable Cost, and the Shut-Down

THE FIRMS SHUT-DOWN DECISION

The Shut-Down Price

THE FIRMS SHUT-DOWN DECISION

Fixed Costs and Sunk Costs

THE BREAK-EVEN PRICE FOR A CORN FARMER

To illustrate the notions of break-even and shut-down

SHORT-RUN SUPPLY CURVES

The Firms Short-Run Supply Curve

SHORT-RUN SUPPLY CURVES

The Firms Short-Run Supply Curve

SHORT-RUN SUPPLY CURVES

The Short-Run Market Supply Curve

SHORT-RUN SUPPLY CURVES

SHORT-RUN SUPPLY CURVES

WIRELESS WOMEN IN PAKISTAN

In Pakistan, many poor villagers cannot afford their own

THE LONG-RUN SUPPLY CURVE FOR AN

THE LONG-RUN SUPPLY CURVE FOR AN

Increasing input price. As an industry grows, it competes with

THE LONG-RUN SUPPLY CURVE FOR AN

Production Cost and Industry Size

THE LONG-RUN SUPPLY CURVE FOR AN

Drawing the Long-Run Market Supply Curve

WOLFRAM MINERS OBEY THE LAW OF SUPPLY

THE WORLDWIDE SUPPLY OF SUGAR

The sugar industry is another example of an increasing-cost industry.

SHORT-RUN AND LONG-RUN EFFECTS

The Short-Run Response to an Increase in Demand

SHORT-RUN AND LONG-RUN EFFECTS

The Long-Run Response to an Increase in Demand

ZONING, LAND PRICES, AND THE SUPPLY CURVE FOR

In many communities, the rental-apartment industry is an

LONG-RUN SUPPLY FOR A

LONG-RUN SUPPLY FOR A

Long-Run Supply Curve for a Constant-Cost Industry

LONG-RUN SUPPLY FOR A

Hurricane Andrew and the Price of Ice

perfectly competitive market

firm-specific demand curve

short-run supply curve