Chapter 6 – Production Behavior: Perfect Competition This chapter examines perfect competition as a market structure. It also develops the profit maximizing producer’s choice of output under perfect competition, and the formation of profits. Finally, it examines how markets adjust to firms making excess profits, or suffering losses in perfect competition.
22
Embed
Chapter 6 – Production Behavior: Perfect Competition zThis chapter examines perfect competition as a market structure. zIt also develops the profit maximizing.
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Chapter 6 – Production Behavior: Perfect Competition
This chapter examines perfect competition as a market structure.
It also develops the profit maximizing producer’s choice of output under perfect competition, and the formation of profits.
Finally, it examines how markets adjust to firms making excess profits, or suffering losses in perfect competition.
Perfect Competition: Key Characteristics
There are a large number of producers within a market for a certain good.
The goods within a market are homogeneous – there exist no quality differences, real or perceived, between the same good made by different producers.
Easy entry and exit (no barriers to entry).
Market Demand and Supply for Good in General
Consider, for example, eggs.
Market Demand – usual market demand curve for eggs, discussed in chapter 4.
Market Supply – usual market supply curve for eggs, discussed in chapter 5.
Market forms an equilibrium price (P*) and equilibrium quantity (Q*) of eggs.
Market Demand for the Individual Producer’s Good
Homogeneous goods individual producer’s eggs are perfect substitutes with other egg producers’ eggs.
Therefore, the Demand for the individual producer’s eggs is described as a horizontal line at the market equilibrium price P*.
Total Revenue for the Individual Producer
Perfect Competition: firms are price takers, they have no power over setting or changing the price of their product.
Total Revenue = (P*)(Q), where Q is the amount they decide to produce.
Total Cost for the Individual ProducerTotal Cost – the total expenditure the firm
spends due to its use of inputs (materials, labor, capital) to produce a certain amount of output.
-- Fixed Cost: the cost to the firm which remains the same no matter how
much it produces (including zero). -- Variable Cost: the cost to the firm which varies based upon how much it produces
Average and Marginal Cost
Average Cost (AC) – firm’s total cost per unit of output.
AC = (Total Cost)/Q
Marginal Cost (MC) – the change in total cost due to a change in output.
MC = (Total Cost)/Q
An Example: King David’s Production Function Output (Lunches) Labor Input (People) 0 0 10 1 25 2 50 3 70 4 86 5 95 6 101 7 104 8 93 9
Computing Total, Average, and Marginal Cost
One needs information about fixed cost, and cost per unit of labor.
King David’s Average Cost (AC) and Marginal Cost (MC) Output (Q) Total Cost AC MC 0 100 -- -- 10 130 13.0 3.0 25 160 6.4 2.0 50 190 3.8 1.2 70 220 3.1 1.5 86 250 2.9 1.9 95 280 2.9 3.3 101 310 3.1 5.0 104 340 3.3 10.0 93 370 4.0 --
Characteristics of Average Cost and Marginal Cost Curves
Both are u-shaped,
When AC is decreasing, MC < AC.When AC is increasing, MC > AC.At the minimum point of the AC curve, MC = AC.
Upward sloping part of MC depicts Law of Diminishing Returns, “relevant region” of production choice.
The Production Decision and Producer Profits
To maximize profits, the individual producer chooses to produce (Q0) where P* = MC (marginal benefit of producing the additional unit equals the marginal cost of producing the additional unit.
Profit = (Total Revenue) – (Total Cost),
Profit = (P*)(Q0) – (Total Cost),
Profit = (P*)(Q0) – (AC)(Q0).
Producer Choice and Profits: King David’s
Suppose that the market price for Marshall Street lunches (P*) equals $10.00.
King David’s chooses output (Q0) where P* = MC.
They compute Profits as Profits = (P*)(Q0) – (AC)(Q0).
Changes the output choice (Q0) and increases the profits of the (surviving) individual firms.
Perfect Competition in the Long-Run
Perfect Competition in the Long-Run: Zero Economic Profits ( = 0) Ultimate long-run position of markets
under perfect competition with the “nice assumptions”.
No incentive for new firms to enter the market.
No incentive for existing firms to exit the market.
The Agility of Markets Under Perfect Competition
The ability of firms to enter highly favorable markets or exit highly unfavorable markets creates “market-resolving” changes in the equilibrium price level.
As a result -- (1) firms don’t maintain permanent advantages and (2) unfavorable markets don’t stay unfavorable for the survivors.