Economics NINTH EDITION Chapter 24 Perfect Competition Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved Learning Objectives 24.1 Distinguish between four market structures 24.2 Explain the short-run output rule and the break-even price 24.3 Explain the shut-down rule 24.4 Explain why the short-run supply curve is positively sloped 24.5 Explain why the long-run industry supply curve may be positively sloped 24.6 Describe the short-run and long-run effects of changes in demand for an increasing-cost industry 24.7 Describe the short-run and long-run effects of changes in demand for a constant-cost industry Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved Perfect Competition (1 of 2) • 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 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved Perfect Competition (2 of 2) Here are the five features of a perfectly competitive market: There are many sellers There are many buyers The product is homogeneous There are no barriers to market entry Both buyers and sellers are price takers Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.1 PREVIEW OF THE FOUR MARKET STRUCTURES (1 of 3) Firm-specific demand curve A curve showing the relationship between the price charged by a specific firm and the quantity the firm can sell Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.1 PREVIEW OF THE FOUR MARKET STRUCTURES (2 of 3) In Panel A, the demand curve facing a monopolist is the market demand curve In Panel B, a perfectly competitive firm takes the market price as given, so the firm-specific demand curve is horizontal The firm can sell all it wants at the market price, but would sell nothing if it charged a higher price Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.1 PREVIEW OF THE FOUR MARKET STRUCTURES (3 of 3) TABLE 24.1 Characteristics of the Four market Structures Characteristics Perfect Competition Monopolistic Oligopoly Monopoly Competition Number of firms Many Many Few One Type of product Homogeneous Differentiated Homogeneous or differentiated Unique Firm-specific Demand is perfectly Demand is elastic but not Demand is less elastic than Firm faces market demand Demand curve Elastic perfectly elastic demand facing monopolistically curve competitive firm Entry conditions Examples No barriers Corn, plain T-shirts No barriers Large barriers from economies Large barriers from economies of scale or government policies of scale or government policies Toothbrushes, music stores, Air travel, automobiles, Local phone service, patented groceries beverages, cigarettes, mobile drugs phone service Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION WIRELESS WOMEN IN PAKISTAN APPLYING THE CONCEPTS #1: How entry costs affect the number of firms in a market? In Pakistan, phone service is now 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 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.2 THE FIRM’S SHORT-RUN OUTPUT DECISION (1 of 5) The Total Approach: Computing Total Revenue and Total Cost TABLE 24.2 Deciding How Much to Produce When the Price Is $12 Output: Shirts per Minute (Q) Fixed Variable Cost (FC) Cost (VC) Total Cost (TC) Total Profit = Marginal Revenue TR –TC Revenue = (TR) Price Marginal Cost (MC) $17 $0 $ 17 $0 -$17 17 22 12 -10 $12 $5 17 23 24 12 17 26 36 10 12 17 13 30 48 18 12 17 18 35 60 25 12 17 25 42 72 30 12 7 17 34 51 84 33 12 17 46 63 96 33 12 12 17 62 79 108 29 12 16 10 17 83 100 120 20 12 21 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.2 THE FIRM’S SHORT-RUN OUTPUT DECISION (2 of 5) The Total Approach: Computing Total Revenue and Total Cost Economic profit is shown by the vertical distance between the totalrevenue curve and the total-cost curve To maximize profit, the firm chooses the quantity of output that generates the largest vertical difference between the two curves Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION THE SHORT RUN SUPPLY CURVE FOR CARGO APPLYING THE CONCEPTS #4: Why is the short-run supply curve positively sloped? Consider the supply of shipping services The law of supply suggests that as the price of shipping increases, the quantity of shipping services will increase The figure below shows the supply curve for shipping services At a relatively low freight rate of $2 per ton, only the most efficient ships operate, and they economize on fuel by traveling at a slow speed As a result, the annual quantity of shipping services is relatively low (70 units per year) At an intermediate freight price of $3 per ton, more ships are engaged: less efficient ships join the fleet In addition, all the ships travel at a greater speed, using more fuel in the process The combination of more ships and faster travel increases the quantity of shipping services provided (85 units per year) At a high freight rate of $7 per ton, all the ships operate and run at full speed, and the quantity of shipping services is 96 units per year Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.5 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY (1 of 5) Long-run market supply curve A curve showing the relationship 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 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.5 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY (2 of 5) The average cost of production increases as the total output increases, for two reasons: 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 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.5 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY (3 of 5) Production Cost and Industry Size TABLE 24.4 Industry Output and Average Production Cost Number of Firms Industry Output Shirts per Firm Total Cost for Typical Firm Average Cost per Shirt 100 600 $42 $7 200 1,200 60 10 300 1,800 78 13 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.5 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY (4 of 5) Drawing the Long-Run Market Supply Curve The long-run market supply curve shows the relationship between the price and quantity supplied in the long run, when firms can enter or leave the industry At each point on the supply curve, the market price equals the longrun average cost of production Because this is an increasing-cost industry, the long-run market supply curve is positively sloped Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.5 THE LONG-RUN SUPPLY CURVE FOR AN INCREASING-COST INDUSTRY (5 of 5) Examples of Increasing-Cost Industries: Sugar and Apartments The sugar industry is an example of an increasing-cost industry 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 The market for apartments is another example of an increasing-cost industry with a positively sloped supply curve Most communities use zoning laws to restrict the amount of land available for apartments As the industry expands by building more apartments, firms compete fiercely for the small amount of land zoned for apartments Housing firms bid up the price of land, increasing the cost of producing apartments Producers can cover these higher production costs only by charging higher rents to tenants In other words, the supply curve for apartments is positively sloped because land prices increase with the total output of the industry, pulling up average cost and necessitating a higher price for firms to make zero economic profit Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION CHINESE COFFEE GROWERS OBEY THE LAW OF SUPPLY APPLYING THE CONCEPTS #5: How producers respond to an increase in price? Pu’er is a city in southern China that is famous for its tea, but is now getting a reputation for its coffee Between 2009 and 2012, the world price of coffee beans nearly doubled Farmers in Pu’er responded to the higher price by doubling the acreage of coffee, and cleared forested hillsides to grow more beans At the relatively high world price, a hectare of coffee earns a family about $10,000 per year, which is three times the earnings from growing tea and five times the earnings from growing rice The farmers’ response illustrates the law of supply: an increase in price increases the quantity supplied Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.6 SHORT-RUN AND LONG-RUN EFFECTS OF CHANGES IN DEMAND (1 of 2) The Short-Run Response to an Increase in Demand An increase in demand for shirts increases the market price to $12, causing the typical firm to produce eight shirts instead of six Price exceeds the average total cost at the eight-shirt quantity, so economic profit is positive Firms will enter the profitable market Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.6 SHORT-RUN AND LONG-RUN EFFECTS OF CHANGES IN DEMAND (2 of 2) The Long-Run Response to an Increase in Demand The short-run supply curve is steeper than the long-run supply curve because of diminishing returns in the short run In the short run, an increase in demand increases the price from $7 (point a) to $12 (point b) In the long run, firms can enter the industry and build more production facilities, so the price eventually drops to $10 (point c) The large upward jump in price after the increase in demand is followed by a downward slide to the new long-run equilibrium price Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION THE UPWARD JUMP AND DOWNWARD SLIDE OF BLUEBERRY PRICES APPLYING THE CONCEPTS #6: What is the time path of market prices after an increase in demand? As we saw in the chapter opener, publicity about the health benefits of antioxidants in blueberries increased the In the short run, the supply of blueberries is inflexible because the number of bushes is fixed, and eager consumers competed for the limited stock, The price increased from $1.44 per pound in 2005 to a peak of $1.85 in 2007 The long run is the few years it takes for newly planted bushes to begin producing marketable blueberries Acreage for blueberries increased from 49,000 acres in 2005 to almost 70,000 acres in 2010 Taking the long run perspective, the market has a relatively flat long-run supply curve, so an increase in demand doesn’t increase the price in the long run The 2010 price equaled the 2005 price Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.7 LONG-RUN SUPPLY FOR A CONSTANT-COST INDUSTRY (1 of 3) Constant-cost industry An industry in which the average cost of production is constant; the long-run supply curve is horizontal Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.7 LONG-RUN SUPPLY FOR A CONSTANT-COST INDUSTRY (2 of 3) Long-Run Supply Curve for a Constant-Cost Industry In a constant-cost industry, input prices not change as the industry grows Therefore, the average production cost is constant and the long-run supply curve is horizontal For the candle industry, the cost per candle is constant at $0.05, so the supply curve is horizontal at $0.05 per candle Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 24.7 LONG-RUN SUPPLY FOR A CONSTANT-COST INDUSTRY (3 of 3) Hurricane Andrew and the Price of Ice A hurricane increases the demand for ice, shifting the demand curve to the right In the short run, the supply curve is relatively steep, so the price rises by a large amount—from $1 to $5 In the long run, firms enter the industry, pulling the price back down Because ice production is a constant-cost industry, the supply is horizontal, and the large upward jump in price is followed by a downward slide back to the original price Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION Economic Detective and the Case of Margarine Prices Applying the Concepts #7: How does a permanent decrease in demand affect the equilibrium price in a constant-cost industry? Between 2000 and 2009, concerns about the health effects of trans-fatty acids decreased the demand for margarine Although total consumption in the U.S decreased by roughly half, the price of margarine in 2009 was roughly the same, in real terms, as the price in 2000 Why didn't the decrease in demand decrease the equilibrium price? The margarine industry is an example of a constant-cost industry As the total output of the industry changes, the prices of the key inputs to the production of margarine don’t change, so the unit cost of production is unaffected by changes in total output Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved KEY TERMS Break-even price Constant-cost industry Firm-specific demand curve Increasing-cost industry Long-run market supply curve Marginal revenue Perfectly competitive market Price taker Short-run market supply curve Short-run supply curve Shut-down price Sunk cost Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved ... differentiated Unique Firm-specific Demand is perfectly Demand is elastic but not Demand is less elastic than Firm faces market demand Demand curve Elastic perfectly elastic demand facing monopolistically... sloped 24. 5 Explain why the long-run industry supply curve may be positively sloped 24. 6 Describe the short-run and long-run effects of changes in demand for an increasing-cost industry 24. 7 Describe...Learning Objectives 24. 1 Distinguish between four market structures 24. 2 Explain the short-run output rule and the break-even price 24. 3 Explain the shut-down rule 24. 4 Explain why the short-run