Principles of Economics - 3e Chapter 8 Perfect Competition

Competition FIGURE Depending on the competition and prices offered , a soybean farmer may choose to grow a different crop ( Credit modification Agronomist Farmer Inspecting Weeds by United Soybean , BY 240 ) CHAPTER OBJECTIVES In this chapter , you will learn about Perfect Competition and Why It Matters How Perfectly Competitive Firms Make Output Decisions Entry and Exit Decisions in the Long Run in Perfectly Competitive Markets Introduction to Perfect Competition BRING IT HOME A Dime a Dozen When you were younger did you babysit , deliver papers , or mow the lawn for money ?

If so , you faced stiff competition from many other competitors who offered identical services . There was nothing to stop others from also offering their services All of you charged the going If you tried to charge more , your customers would simply buy from someone else . These conditions are very similar to the conditions agricultural growers face .

188 Perfect Competition Growing a crop may be more difficult to start than a babysitting or lawn mowing service , but growers face the same competition . In the grand scale of world agriculture , farmers face competition from thousands of others because they sell an identical product . After all , winter wheat is winter wheat , but if they it hard to make money with that crop , it is relatively easy for farmers to leave the marketplace for another crop . In this case , they do not sell the family farm , they switch crops . Take the case of the upper Midwest region of the United many generations the area was called King According to the United States Department of Agriculture National Agricultural Statistics Service , statistics by state , in 1997 , million acres of wheat and acres of corn were planted in North Dakota . In the intervening 25 or so years has the mix of crops changed ?

Since it is relatively easy to switch crops , did farmers change what they planted in response to changes in relative crop prices ?

We will out at chapter end . In the meantime , let consider the topic of this perfectly competitive market . This is a market in which entry and exit are relatively easy and competitors are a dime a Most businesses face two realities no one is required to buy their products , and even customers who might want those products may buy from other businesses instead . Firms that operate in perfectly competitive markets face this reality . In this chapter , you will learn how such make decisions about how much to produce , how much they make , whether to stay in business or not , and many others . Industries differ from one another in terms of how many sellers there are in a market , how easy or difficult it is for a new to enter , and the type of products that they sell . Economists refer to this as an industry market structure . In this chapter , we focus on perfect competition . However , in other chapters we will examine other industry types Monopoly and Monopolistic Competition and . Perfect Competition and Why It Matters LEARNING OBJECTIVES By the end of this section , you will be able to Explain the characteristics of a perfectly competitive market Discuss how perfectly competitive react in the short run and in the long run Firms are in perfect competition when the following conditions occur ( many produce identical products ( many buyers are available to buy the product , and many sellers are available to sell the product ( sellers and buyers have all relevant information to make rational decisions about the product that they are buying and selling and ( can enter and leave the market without any other words , there is free entry and exit into and out of the market . A perfectly competitive is known as a price taker , because the pressure of competing forces it to accept the prevailing equilibrium price in the market . Ifa in a perfectly competitive market raises the price of its product by so much as a penny , it will lose all of its sales to competitors . When a wheat grower , as we discussed in the Bring It Home feature , wants to know the going price of wheat , they have to check on the computer or listen to the radio . Supply and demand in the entire market solely determine the market price , not the individual farmer . A perfectly competitive must be a very small player in the overall market , so that it can increase or decrease output without noticeably affecting the overall quantity supplied and price in the market . A perfectly competitive market is a hypothetical extreme however , producers in a number of industries do face many competitor selling highly similar goods , in which case they must often act as price takers . Economists often use agricultural markets as an example . The same crops that different farmers grow are largely interchangeable . According to the United States Department of Agriculture monthly reports , in December 2021 , corn farmers received an average of per bushel . A corn farmer who attempted to sell at per bushel would not have found any buyers . A perfectly competitive will not sell below the equilibrium price either . Why should they when they can sell all they want at the higher price ?

Other examples Access for free at How Perfectly Competitive Firms Make Output Decisions 189 of agricultural markets that operate in close to perfectly competitive markets are small roadside produce markets and small organic farmers . LINK up Visit this website ( commodities ) that reveals the current value commodities . This chapter examines how decide how much to produce in perfectly competitive markets . Such will analyze their costs as we discussed in the chapter on Production Costs and Industry Structure . In the short run , the perfectly competitive will seek the quantity of output where are highest or , if are not possible , where losses are lowest . In the long run , positive economic will attract competition as other enter the market . Economic losses will cause to exit the market . Ultimately , perfectly competitive markets will attain equilibrium when no new want to enter the market and existing do not want to leave the market , as economic have been driven down to zero . How Perfectly Competitive Firms Make Output Decisions LEARNING OBJECTIVES By the end of this section , you will be able to Calculate by comparing total revenue and total cost Identify and losses with the average cost curve Explain the shutdown point Determine the price at which a should continue producing in the short run A perfectly competitive has only one major decision to , what quantity to produce . To understand this , consider a different way out the basic Total revenue Total cost ( Price ) Quantity produced ) Average cost ) Quantity produced ) Since a perfectly competitive must accept the price for its output as determined by the products market demand and supply , it can not choose the price it charges . This is already determined in the equation , and so the perfectly competitive can sell any number of units at exactly the same price . It implies that the faces a perfectly elastic demand curve for its product buyers are willing to buy any number of units of output from the at the market price . When the perfectly competitive chooses what quantity to produce , then this with the prices prevailing in the market for output and determine the total revenue , total costs , and ultimately , level of . Determining the Highest Profit by Comparing Total Revenue and Total Cost A perfectly competitive can sell as large a quantity as it wishes , as long as it accepts the prevailing market price . The formula above shows that total revenue depends on the quantity sold and the price charged . If the sells a higher quantity of output , then total revenue will increase . If the market price of the product increases , then total revenue also increases whatever the quantity sold . As an example of how a perfectly competitive decides what quantity to produce , consider the case ofa small farmer who produces raspberries and sells them frozen for per pack . Sales of one pack of raspberries will bring in , two packs will be , three packs will be 12 , and so on . If , for example , the price of frozen raspberries doubles to per pack , then sales of one pack of raspberries will be , two packs will be 16 , three packs will be 24 , and so on . Table shows total revenue and total costs for the raspberry farm these data also appear in Figure . The horizontal axis shows the quantity of frozen raspberries produced in packs . The vertical axis shows both total revenue and total costs , measured in dollars . The total cost curve intersects with the vertical axis at a value that shows the level of costs , and then slopes upward . All these cost curves follow the same

190 Perfect Competition characteristics as the curves that we covered in the Production Costs and Industry Structure chapter . Loss Profit Loss 800 Total cost 600 Total revenue 400 200 Total Total Revenue ( 40 60 00 20 100 Quantity ( packs of raspberries ) Profit FIGURE Total Cost and Total Revenue at the Raspberry Farm Total revenue for a perfectly competitive is a straight line sloping up . The slope is equal to the price of the good . Total cost also slopes up , but with some curvature . At higher levels of output , total cost begins to slope upward more steeply because of diminishing marginal returns . The maximum will occur at the quantity where the difference between total revenue and total cost is largest . Quantity Total Cost Total Revenue ( 62 62 10 90 40 50 20 110 80 30 30 126 120 40 138 160 22 50 150 200 50 60 165 240 75 70 190 280 90 80 230 320 90 90 296 360 64 100 400 400 110 550 440 110 120 715 480 235 TABLE Total Cost and Total Revenue at the Raspberry Farm Based on its total revenue and total cost curves , a perfectly competitive like the raspberry farm can Access for free at

How Perfectly Competitive Firms Make Output Decisions 191 calculate the quantity of output that will provide the highest level of . At any given quantity , total revenue minus total cost will equal . One way to determine the most quantity to produce is to see at what quantity total revenue exceeds total cost by the largest amount . Figure shows total revenue , total cost and using the data from Table . The vertical gap between total revenue and total cost is , for example , at 60 , 240 and 165 . The difference is 75 , which is the height of the curve at that output level . The does make a at every evel of output . In this example , total costs will exceed total revenues at output levels from to approximately 30 , and so over this range of output , the will be making losses . At output levels from 40 to 100 , total revenues exceed total costs , so the is earning . However , at any output greater than 100 , total costs again exceed total revenues and the is making increasing losses . Total appear in the co of Table . Maximum occurs at an output between 70 and 80 , when equals 90 . A higher price would mean that total revenue would higher for every quantity sold . A lower price would mean that total revenue would be lower for every quantity sold . What happens if the price drops low enough so that the total revenue line is completely below the total cost curve that is , at every level of output , total costs are higher than total revenues ?

In this instance , the best the can do is to suffer losses . However , a maximizing will prefer the quantity of output total revenues come closest to total costs and thus where the losses are smallest . Later we will see that sometimes it will make sense or the to close , rather than stay in operation producing output . Comparing Marginal Revenue and Marginal Costs The approach that we described in the previous section , using total revenue and total cost , is not the only approach to determining the maximizing level of output . In this section , we provide an alternative approach which uses marginal revenue and marginal cost . Firms often do not have the necessary data they need to draw a complete total cost curve for all levels of production . They can not be sure of what total costs would look like if they , say , doubled production or cut production in half , because they have not tried it . Instead , experiment . They produce a slightly greater or lower quantity and observe how it affects . In economic terms , this practical approach to maximizing means examining how changes in production affect marginal revenue and marginal cost . Figure presents the marginal revenue and marginal cost curves based on the total revenue and total cost in Table . The marginal revenue curve shows the additional revenue gained from selling one more unit . As mentioned before , a in perfect competition faces a perfectly elastic demand curve for its is , the demand curve is a horizontal line drawn at the market price level . This also means that the marginal revenue curve is the same as the demand curve Every time a consumer demands one more unit , the sells one more unit and revenue increases by exactly the same amount equal to the market price . In this example , every time the sells a pack of frozen raspberries , the revenue increases by . Table shows an example of this . This condition only holds for price taking in perfect competition where marginal revenue price The formula for marginal revenue is change in total revenue marginal revenue . change in quantity

192 Perfect Competition Price Quantity Total Revenue Marginal Revenue 12 16 TABLE Notice that marginal revenue does not change as the produces more output . That is because under perfect competition , the price is determined through the interaction of supply and demand in the market and does not change as the farmer produces more ( keeping in mind that , due to the relative small size of each , increasing their supply has no impact on the total market supply where price is determined ) Since a perfectly competitive is a price taker , it can sell whatever quantity it wishes at the determined price . We calculate marginal cost , the cost per additional unit sold , by dividing the change in total cost by the change in quantity . The formula for marginal cost is change in total cost marginal cost , change in quantity Ordinarily , marginal cost changes as the produces a greater quantity . In the raspberry farm example , in Figure 83 and Table , marginal cost at declines as production increases from 10 to 20 to 30 to 40 packs of represents the area of increasing marginal returns that is not uncommon at low levels . At some point , though , marginal costs start to increase , displaying the typical pattern of diminishing marginal returns . Ifthe is producing at a quantity where , like 40 or 50 packs of raspberries , then it can increase by increasing output because the marginal revenue is exceeding the marginal cost . If the is producing at a quantity where , like 90 or 100 packs , then it can increase by reducing output because the reductions in marginal cost will exceed the reductions in marginal revenue . The choice of output will occur where ( or at a choice close to that point ) 35 ! 30 Marginal cost ) It 25 20 15 10 Profit maximizing point Marginal revenue 20 40 60 80 100 120 140 Quantity ( packs of raspberries ) FIGURE Marginal Revenues and Marginal Costs at the Raspberry Farm Individual Farmer For a perfectly competitive , the marginal revenue ( curve is a horizontal line because it is equal to the price of the good , which is determined by the market , as Figure illustrates . The marginal cost ( curve is sometimes initially Access for free at

How Perfectly Competitive Firms Make Output Decisions , it there is a region of increasing marginal returns at low levels of output , but is eventually at higher levels of output as diminishing marginal returns kick in . Supply Market Price ' Demand 800 Market Quantity ( packs of raspberries ) FIGURE Supply , Demand , and Equilibrium Price in the Market for Raspberries The equilibrium price of raspberries is determined through the interaction of market supply and market demand at . Quantity Total Cost Marginal Cost Total Revenue Marginal Revenue 62 62 10 90 40 50 20 110 80 30 30 126 120 40 138 160 22 50 150 200 50 60 165 240 75 70 190 280 90 80 230 320 90 90 296 360 64 100 400 400 110 550 440 110 120 715 480 235 TABLE Marginal Revenues and Marginal Costs at the Raspberry Farm In this example , the marginal revenue and marginal cost curves cross at a price of a quantity of 80 produced . If the farmer started out producing at a level of 60 , and then experimented with increasing production to 70 , marginal revenues from the increase in production would exceed marginal so would rise . The farmer has an incentive to keep producing . At a level of output of 80 , marginal cost and 193

194 Perfect Competition marginal revenue are equal so doesn change . If the farmer then experimented further with increasing production from 80 to 90 , he would that marginal costs from the increase in production are greater than marginal revenues , and so would decline . The choice for a perfectly competitive will occur at the level of output where marginal revenue is equal to marginal is , where . This occurs at 80 in the . Does Profit Maximization Occur at a Range of Output or a Specific Level of Output ?

Table shows that maximum occurs at any output level between 70 and 80 units of output . But occurs only at 80 units of output . How can we explain this slight discrepancy ?

As long as , a seeking should keep expanding production . Expanding production into the zone where reduces economic . It true that is the same at 70 and 80 , but it only when the goes beyond that that it will see that fall . Thus , is the signal to stop expanding , so that is the level of output they should target . Because the marginal revenue received by a perfectly competitive is equal to the price , we can also write the rule for a perfectly competitive as a recommendation to produce at the quantity of output where . Profits and Losses with the Average Cost Curve Does maximizing ( producing where ) imply an actual economic ?

The answer depends on the relationship between price and average total cost , which is the average or margin . If the market price is higher than the average cost of production for that quantity produced , then the margin is positive and the will earn . Conversely , if the market price is lower than the average cost , the margin is negative and the will suffer losses . You might think that , in this situation , the may want to shut down immediately . Remember , however , that the has already paid for costs , such as equipment , so it may continue to produce for a while and incur a loss . Table continues the raspberry farm example . Figure 85 illustrates the three possible scenarios ( a ) where price intersects marginal cost at a level above the average cost curve , where price intersects marginal cost at a level equal to the average cost curve , and ( where price intersects marginal cost at a level below the average cost curve . Access for free at

How Perfectly Competitive Firms Make Output Decisions Marginal cost Marginal cost ' Average cost Average cost i i Marginal revenue . i , Marginal revenue ' I 10 20 30 40 50 60 70 80 90100 10 20 30 40 50 60 70 80 90100 Quantity ( packs of raspberries ) Quantity ( packs of raspberries ) a ) Price IS above average cost ( Price equals average cost ' A cos Average cost 32 A a A i ' Eu Marginal a . revenue 10 20 30 40 50 60 70 80 90100 Quantity ( packs of raspberries ) Price is below average cost FIGURE Price and Average Cost at the Raspberry Farm In ( a ) price intersects marginal cost above the average cost curve . Since price is greater than average cost , the is making a . In ( price intersects marginal cost at the minimum point of the average cost curve . Since price is equal to average cost , the is breaking even . In ( price intersects marginal cost below the average cost curve . Since price is less than average cost , the firm is making a loss . First consider a situation where the price is equal to for a pack of frozen raspberries . The rule for a maximizing perfectly competitive is to produce the level of output where Price , so the raspberry farmer will produce a quantity of approximately 85 , which is labeled as in Figure ( a ) Remember that the area of a rectangle is equal to its base multiplied by its height . The farm total revenue at this price will be shown by the rectangle from the origin over to a quantity of 85 packs ( the base ) up to point ( the height ) over to the price of , and back to the origin . The average cost of producing 80 packs is shown by point or about . Total costs will be the quantity of 85 times the average cost of , which is shown by the area of the rectangle from the origin to a quantity of 90 , up to point , over to the vertical axis and down to the origin . The difference between total revenues and total costs is . Thus , will be the blue shaded rectangle on top . We calculate this as

196 Perfect Competition profit total total cost ( 85 ) 85 ) Or , we can calculate it as profit ( average cost ) quantity ( 85 Now consider Figure ( where the price has fallen to for a pack of frozen raspberries . Again , the perfectly competitive will choose the level where Price , but in this case , the quantity produced will be 75 . At this price and output level , where the marginal cost curve is crossing the average cost curve , the price the receives is exactly equal to its average cost of production . We call this the break even point . The farm total revenue at this price will be shown by the large shaded rectangle from the origin over to a quantity of 75 packs ( the base ) up to point ( the height ) over to the price of , and back to the origin . The height of the average cost curve at 75 , point , shows the average cost this quantity . Total costs will be the quantity of 75 times the average cost of , which is shown by the area of the rectangle from the origin to a quantity of 75 , up to point , over to the vertical axis and down to the origin . It should be clear that the rectangles for total revenue and total cost are the same . Thus , the is making zero . The calculations are as follows profit total total cost ( 75 ) 75 ) Or , we can calculate it as profit ( average cost ) quantity ( 75 In Figure ( the market price has fallen still further to for a pack of frozen raspberries . At this price , marginal revenue intersects marginal cost at a quantity of 65 . The farm total revenue at this price will be shown by the large shaded rectangle from the origin over to a quantity of 65 packs ( the base ) up to point ( the height ) over to the price of , and back to the origin . The average cost 65 packs is shown by Point or shows the average cost of producing 50 packs is about . Total costs will be the quantity of 65 times the average cost of , which the area of the rectangle from the origin to a quantity of 50 , up to point , over to the vertical axis and down to the origin shows . It should be clear from examining the two rectangles that total revenue is less than total cost . Thus , the is losing money and the loss ( or negative ) will be the rectangle . The calculations are profit ( total total cost ) 65 ) 65 ) Or profit ( average cost ) quantity ( 65 Access for free at

How Perfectly Competitive Firms Make Output Decisions 197 If the market price that perfectly competitive receives leads it to produce at a quantity where the price is greater than average cost , the will earn . If the price the receives causes it to produce at a quantity where price equals average cost , which occurs at the minimum point of the AC curve , then the earns zero . Finally , if the price the receives leads it to produce at a quantity where the price is less than average cost , the will earn losses . Table summarizes this . If Then Price ATC Firm earns an economic Price ATC Firm earns zero economic Price ATC Firm earns a loss TABLE CLEAR IT UP Which intersection should choose ?

At a price of , intersects at two points 20 and 65 . It never makes sense for a to choose a level of output on the downward sloping part of the curve , because the profit is lower ( the loss is bigger ) Thus , the correct choice of output is 65 . The Shutdown Point The possibility that a may earn losses raises a question Why can the not avoid losses by shutting down and not producing at all ?

The answer is that shutting down can reduce variable costs to zero , but in the short run , the has already paid for costs . As a result , if the produces a quantity of zero , it would still make losses because it would still need to pay for its costs . Therefore when a is experiencing losses , it must face a question should it continue producing or should it shut down ?

As an example , consider the situation of the Yoga Center , which has signed a contract to rent space that costs per month . Ifthe decides to operate , its marginal costs for hiring yoga teachers is for the month . If the shuts down , it must still pay the rent , but it would not need to hire labor . Table shows three possible scenarios . In the scenario , the Yoga Center does not have any clients , and therefore does not make any revenues , in which case it faces losses of equal to the costs . In the second scenario , the Yoga Center has clients that earn the center revenues of for the month , but ultimately experiences losses of due to having to hire yoga instructors to cover the classes . In the third scenario , the Yoga Center earns revenues of for the month , but experiences losses of . In all three cases , the Yoga Center loses money . In all three cases , when the rental contract expires in the long run , assuming revenues do not improve , the should exit this business . In the short run , though , the decision varies depending on the level of losses and whether the can cover its variable costs . In scenario , the center does not have any revenues , so hiring yoga teachers would increase variable costs and losses , so it should shut down and only incur its costs . In scenario , the center losses are greater because it does not make enough revenue to offset the increased variable costs , so it should shut down immediately and only incur its costs . If price is below the minimum average variable cost , the must shut down . In contrast , in scenario the revenue that the center can earn is high enough that the losses diminish when it remains open , so the center should remain open in the short run .

198 Perfect Competition Scenario If the center shuts down now , revenues are zero but it will not incur any variable costs and would only need to pay costs of . profit total ( fixed costs variable cost ) Scenario The center earns revenues of , and variable costs are . The center should shut down now . profit total revenue ( fixed costs variable cost ) Scenario The center earns revenues of , and variable costs are . The center should continue in business . profit total revenue ( fixed costs variable cost ) TABLE Should the Yoga Center Shut Down Now or Later ?

Figure illustrates the lesson that remaining open requires the price to exceed the average variable cost . When the is operating below the point , where price equals average cost , it is operating at a loss so it faces two options continue to produce and lose money or shutdown . Which option is preferable ?

The one that loses the least money is the best choice . At a price of per pack , as Figure ( a ) illustrates , if the farm stays in operation it will produce at a level of 65 packs of raspberries , and it will make losses of ( as explained earlier ) The alternative would be to shut down and lose all the costs of . Since losing is preferable to losing , the maximizing ( or in this case the loss minimizing ) choice is to stay in operation . The key reason is because price is above average variable cost . This means that at the current price the farm can pay all its variable costs , and have some revenue left over to pay some of the costs . So the loss represents the part of the costs the farm ca pay , which is less than the entire costs . However , if the price declined to per pack , as Figure ( shows , and if the applied its rule of producing where , it would produce a quantity of 60 . This price is below average variable cost for this level of output . Ifthe farmer can not pay workers ( the variable costs ) then it has to shut down . At this price and output , total revenues would be 90 ( quantity of 60 times price of ) and total cost would be 165 , for overall losses of 75 . If the farm shuts down , it must pay only its costs of 62 , so shutting down is preferable to selling at a price of per pack . Access for free at

How Perfectly Competitive Firms Make Output Decisions 199 75 12 75 12 . Marginal cost 10 Marginal cost Avera cost ! Average cost ) a a A Image Average variable Cost cost revenue Marginal revenue i 20 40 60 80 100 120 20 40 60 80 100 120 Quantity ( packs of raspberries ) Quantity ( packs of raspberries ) a ) Price is above average variable cost ( Price is average variable cost FIGURE The Shutdown Point forthe Raspberry Farm In ( a ) the farm produces at a level of 65 . It is making losses of , but price is above average variable cost , so it continues to operate . In ( total revenues are 90 and total cost is 165 , for overall losses of 75 . If the farm shuts down , it must pay only its costs of 62 . Shutting down is preferable to selling at a price of per pack . Looking at Table , if the price falls below about , the minimum average variable cost , the must shut down . Quantity Average Variable Cost Average Cost Marginal Cost AC . 10 20 30 40 50 60 70 80 90 100 110 120 TABLE Cost of Production for the Raspberry Farm

200 Perfect Competition The intersection of the average variable cost curve and the marginal cost curve , which shows the price below which the would lack enough revenue to cover its variable costs , is called the shutdown point . If the perfectly competitive faces a market price above the shutdown point , then the is at least covering its average variable costs . At a price above the shutdown point , the is also making enough revenue to cover at least a portion of costs , so it should limp ahead even if it is making losses in the short run , since at least those losses will be smaller than if the shuts down immediately and incurs a loss equal to total costs . However , if the is receiving a price below the price at the shutdown point , then the is not even covering its variable costs . In this case , staying open is making the losses larger , and it should shut down immediately . To summarize , if price minimum average variable cost , then shuts down price minimum average variable cost , then stays in business Outcomes for Perfectly Competitive Firms The average cost and average variable cost curves divide the marginal cost curve into three segments , as Figure shows . At the market price , which the perfectly competitive accepts as given , the maximizing chooses the output level where price or marginal revenue , which are the same thing for a perfectly competitive , is equal to marginal cost . Break Even point Profit zone AC . Shutdown palm ' Loss but continue operating in zone Shutdown zone Output FIGURE Profit , Loss , Shutdown We can divide the marginal cost curve into three zones , based on where it is crossed by the average cost and average variable cost curves . We call the point where crosses AC the break even point . If the firm is operating where the market price is at a level higher than the break even point , then price will be greater than average cost and the firm is earning . If the price is exactly at the break even point , then the firm is making zero . If price falls in the zone between the shutdown point and the break even point , then the firm is making losses but will continue to operate in the short run , since it is covering its variable costs , and more if price is above the price . However , if price falls below the price at the shutdown point , then the firm will shut down immediately , since it is not even covering its variable costs . First consider the upper zone , where prices are above the level where marginal cost ( crosses average cost ( AC ) at the zero point . At any price above that level , the will earn in the short run . If the price falls exactly on the break even point where the and AC curves cross , then the earns zero . If a price falls into the zone between the break even point , where crosses AC , and the shutdown point , where crosses , the will be making losses in the short since the is more than covering its Access for free at

How Perfectly Competitive Firms Make Output Decisions 201 variable costs , the losses are smaller than if the shut down immediately . Finally , consider a price at or below the shutdown point where crosses . At any price like this one , the will shut down immediately , because it can not even cover its variable costs . Marginal Cost and the Firm Supply Curve For a perfectly competitive , the marginal cost curve is identical to the supply curve starting from the minimum point on the average variable cost curve . To understand why this perhaps surprising insight holds true , think about what the supply curve means . A checks the market price and then looks at its supply curve to decide what quantity to produce . Now , think about what it means to say that a will maximize its by producing at the quantity where . This rule means that the checks the market price , and then looks at its marginal cost to determine the quantity to makes sure that the price is greater than the minimum average variable cost . In other words , the marginal cost curve above the minimum point on the average variable cost curve becomes the supply curve . LINK up Watch this video that addresses how drought in the United States can impact food prices across the world . As we discussed in the chapter on Demand and Supply , many of the reasons that supply curves shift relate to underlying changes in costs . For example , a lower price of key inputs or new technologies that reduce production costs cause supply to shift to the right . In contrast , bad weather or added government regulations can add to costs of certain goods in a way that causes supply to shift to the left . We can also interpret these shifts in the supply curve as shifts of the marginal cost curve . A shift in costs of production that increases marginal costs at all levels of shifts upward and to the cause a perfectly competitive to produce less at any given market price . Conversely , a shift in costs of production that decreases marginal costs at all levels of output will shift downward and to the right and as a result , a competitive will choose to expand its level of output at any given price . The following Work It Out feature will walk you through an example . At What Price Should the Firm Continue Producing in the Short Run ?

To determine the economic condition a in perfect competition , follow the steps outlined below . Use the data in Table . ATC 28 20 28 20 20 28 20 25 28 20 35 28 20 52 28 20 80 TABLE 202 Perfect Competition Step . Determine the cost structure for the . For a given total costs and variable costs , calculate total cost , average variable cost , average total cost , and marginal cost . Follow the formulas given in the Production Costs and Industry Structure chapter . These calculations are in Table . we Ave ( 23 20 20 ( 20 ) 23 20 20 40 ( 20 23 20 25 45 ( 40 ) 45 ) 23 20 35 55 ( 10 ( 55 ) 23 20 52 72 ( 17 ( 72 ) 23 20 80 100 ( 28 Step . Determine the market price that the receives for its product . Since the in perfect competition is a price taker , the market price is constant . With the given price , calculate total revenue as equal to price multiplied by quantity for all output levels produced . In this example , the given price is 28 . You can see that in the second column of Table . Quantity Price Total Revenue ( 28 28 28 28 28 28 28 56 28 28 84 A 28 28 28 28 140 TABLE Step . Calculate as total cost subtracted from total revenue , as Table shows . Access for free at

How Perfectly Competitive Firms Make Output Decisions 203 Quantity Total Revenue ( 20 20 20 28 40 40 12 56 45 11 84 55 29 112 72 40 140 100 40 TABLE Step . To the output level , look at the Marginal Cost column ( at every output level produced ) as Table shows , and determine where it is equal to the market price . The output level where price equals the marginal cost is the output level lat maximizes . ATC 28 20 20 20 28 20 20 40 20 28 12 28 20 25 45 56 11 28 20 35 55 10 84 29 28 20 52 72 17 112 40 28 20 80 100 28 140 40 TABLE Step . Once you have determined the output level ( in this case , output quantity ) you can look at the amount of made ( in this case , 40 ) Step . If the is making economic losses , the needs to determine whether it produces the output level where price equals marginal revenue and equals marginal cost or it shuts down and only incurs its costs . Step . For the output level where marginal revenue is equal to marginal cost , check if the market price is greater than the average variable cost of producing that output level . If but ATC , then the continues to produce in the , making economic losses . If , then the stops producing and only incurs its costs . In this example , the price of 28 is greater than the ( units of output , so the continues producing .

204 Perfect Competition Entry and Exit Decisions in the Long Run LEARNING OBJECTIVES By the end of this section , you will be able to Explain how entry and exit lead to zero in the long run Discuss the adjustment process is impossible to precisely the line between the short run and the long run with a stopwatch , or even with a calendar . It varies according to the business . Therefore , the distinction between the short run and the long run is more technical in the short run , can not change the usage of inputs , while in the ong run , the can adjust all factors of production . a competitive market , are a red cape that incites businesses to charge . If a business is making a in the short run , it has an incentive to expand existing factories or to build new ones . New may start , as well . When new enter the industry in response to increased industry it is called entry . are the black thundercloud that causes businesses to . If a business is making losses in the short run , it will either keep limping along orjust shut down , depending on whether its revenues are covering its variable costs . But in the long run , that are facing losses will cease production altogether . The of reducing production in response to a sustained pattern of losses is called exit . The following Clear It feature discusses where some of these losses might come from , and the reasons why some go out of business . CLEAR IT UP Why do firms cease to exist ?

Can we say anything about what causes a to exit an industry ?

are the measurement that determines whether a business stays operating or not . Individuals start businesses with the purpose of making . They invest their money , time , effort , and many other resources to produce and sell something that they hope will give them something in return . Unfortunately , not all businesses are successful , and many new startups soon realize that their business venture must eventually end . In the model of perfectly competitive , those that consistently can not make money will exit , which is a nice , bloodless word for a more painful process . When a business fails , after all , workers lose their jobs , investors lose their money , and owners and managers can lose their dreams . Many businesses fail . The Small Business Administration indicates that in 2011 , new entered , and failed . Sometimes a business fails because of poor management or workers who are not very productive , or because of tough domestic or foreign competition . Businesses also fail from a variety of causes . For example , conditions of demand and supply in the market may shift in an unexpected way , so that the prices that a business charges for outputs fall or the prices for inputs rise . With millions of businesses in the economy , even a small fraction of them failing will affect many business failures can be very hard on the workers and managers directly involved . However , from the standpoint of the overall economic system , business exits are sometimes a necessary evil if a system is going to offer a flexible mechanism for satisfying customers , keeping costs low , and inventing new products . How Entry and Exit Lead to Zero Profits in the Long Run No perfectly competitive acting alone can affect the market price . However , the combination of many entering or exiting the market will affect overall supply in the market . In turn , a shift in supply for the market as a whole will affect the market price . Entry and exit to and from the market are the driving forces behind a process that , in the long run , pushes the price down to minimum average total costs so that all Access for free at

Entry and Exit Decisions in the Long Run 205 are earning a zero . To understand how for a perfectly competitive will evaporate in the long run , imagine the following situation . The market is in equilibrium , where all earn zero economic producing the output level where and AC . No has the incentive to enter or leave the market . Let say that the products demand increases , and with that , the market price goes up . The existing in the industry are now facing a higher price than before , so they will increase production to the new output level where . This will temporarily make the market price rise above the minimum point on the average cost curve , and therefore , the existing in the market will now be earning economic . However , these economic attract other to enter the market . Entry of many new causes the market supply curve to shift to the right . As the supply curve shifts to the right , the market price starts decreasing , and with that , economic fall for new and existing . As long as there are still in the market , entry will continue to shift supply to the right . This will stop whenever the market price is driven down to the level , where no is earning economic . losses will fade away by reversing this process . Say that the market is in equilibrium . This time , instead , demand decreases , and with that , the market price starts falling . The existing in the industry are now facing a lower price than before , and as it will be below the average cost curve , they will now be making economic losses . Some will continue producing where the new , as long as they are able to cover their average variable costs . Some will have to shut down immediately as they will not be able to cover their average variable costs , and will then only incur their costs , minimizing their losses . Exit of many causes the market supply curve to shift to the left . As the supply curve shifts to the left , the market price starts rising , and economic losses start to be lower . This process ends whenever the market price rises to the level , where the existing are no longer losing money and are at zero again . Thus , while a perfectly competitive can earn in the short run , in the long run the process will push down prices until they reach the level . Conversely , while a perfectly competitive may earn losses in the short run , will not continually lose money . In the long run , making losses are able to escape from their costs , and their exit from the market will push the price back up to the level . In the long run , this process of entry and exit will drive the price in perfectly competitive markets to the point at the bottom of the AC curve , where marginal cost crosses average cost . The Adjustment and Industry Types Whenever there are in an industry , costs of production for the existing and new could either stay the same , increase , or even decrease . Therefore , we can categorize an industry as being ( a industry ( as demand increases , the cost of production for stays the same ) an increasing cost industry ( as demand increases , the cost for increases ) or ( a decreasing cost industry ( as demand increases the costs for the decreases ) For a industry , whenever there is an increase in market demand and price , then the supply curve shifts to the right with new entry and stops at the point where the new equilibrium intersects at the same market price as before . This is the case of constant returns to scale , which we discussed earlier in the chapter on Production , Costs , and Industry Structure . However , why will costs remain the same ?

In this type of industry , the supply curve is very elastic . Firms can easily supply any quantity that consumers demand . In addition , there is a perfectly elastic supply of can easily increase their demand for employees , for example , with no increase to wages . Tying in to our Bring it Home discussion , an increased demand for ethanol in recent years has caused the demand for corn to increase . Consequently , many farmers switched from growing wheat to growing corn . Agricultural markets are generally good examples of cost industries . For an increasing cost industry , as the market expands , the old and new experience increases in their

206 Perfect Competition costs of production , which makes the new level intersect at a higher price than before . Here companies may have to deal with limited inputs , such as skilled labor . As the demand for these workers rises , wages rise and this increases the cost of production for all . The industry supply curve in this type of industry is more inelastic . For a decreasing cost industry , as the market expands , the old and new experience lower costs of production , which makes the new level intersect at a lower price than before . In this case , the industry and all the in it are experiencing falling average total costs . This can be due to an improvement in technology in the entire industry or an increase in the education of employees . industries may be a good example of a decreasing cost market . Figure ( a ) presents the case of an adjustment process in a industry . Whenever there are output in this type of industry , the outcome implies more output produced at exactly the same original price . Note that supply was able to increase to meet the increased demand . When the before and after , the resulting line is the long run supply ( curve in perfectly competitive markets . In this case , it is a curve . Figure ( and Figure ( present the cases for an increasing cost and decreasing cost industry , respectively . For an increasing cost industry , the is upward sloping , while for a decreasing cost industry , the is downward sloping . Price Price Price 03 Quantity Quantity Quantity ( a ) Constant cost ( Increasing cost ( Decreasing cost FIGURE Adjustment Process in Industry In ( a ) demand increased and supply met it . Notice that the supply increase is equal to the demand increase . The result is that the equilibrium price stays the same as quantity sold increases . In ( notice that sellers were not able to increase supply as much as demand . Some inputs were scarce , or wages were rising . The equilibrium price rises . In ( sellers easily increased supply in response to the demand increase . Here , new technology or economies of scale caused the large increase in supply , resulting in declining equilibrium price . Efficiency in Perfectly Competitive Markets LEARNING OBJECTIVES By the end of this section , you will be able to Apply concepts and to perfectly competitive markets Compare the model competition to markets When in perfectly competitive markets combine with consumers , something remarkable happens the resulting quantities of outputs of goods and services demonstrate both productive and ( terms that we introduced in Choice in a World of Scarcity . Productive means producing without waste , so that the choice is on the production possibility frontier . In the long run in a perfectly competitive market , because of the process of entry and exit , the price in the market is equal to the minimum of the average cost curve . In other words , produce and sell goods at the lowest possible average cost . means that among the points on the production possibility frontier , the chosen point is Access for free at

Efficiency in Perfectly Competitive Markets 207 socially least in a particular and sense . In a perfectly competitive market , price will be equal to the marginal cost of production . Think about the price that one pays for a good as a measure of the social one receives for that good after all , willingness to pay conveys what the good is worth to a buyer . Then think about the marginal cost of producing the good as representing notjust the cost for the , but more broadly as the social cost that good . When perfectly competitive follow the rule that are maximized by producing at the quantity where price is equal to marginal cost , they are thus ensuring that the social they receive from producing a good are in line with the social costs of production . To explore what economists mean by , it is useful to walk through an example . Begin by assuming that the market for wholesale is perfectly competitive , and so . Now , consider what it would mean if in that market produced a lesser quantity of . At a lesser quantity , marginal costs will not yet have increased as much , so that price will exceed marginal cost that is , In that situation , the to society as a whole of producing additional goods , as measured by the willingness of consumers to pay for marginal units of a good , would be higher than the cost of the inputs of labor and physical capital needed to produce the marginal good . In other words , the gains to society as a whole from producing additional marginal units will be greater than the costs . Conversely , consider what it would mean if , compared to the level at the choice when , produced a greater quantity of . At a greater quantity , marginal costs of production will have increased so that . In that case , the marginal costs of producing additional is greater than the to society as measured by what people are willing to pay . For society as a whole , since the costs are outstripping the , it will make sense to produce a lower quantity of such goods . When perfectly competitive maximize their by producing the quantity where , they also assure that the to consumers of what they are buying , as measured by the price they are willing to pay , is equal to the costs to society of producing the marginal units , as measured by the marginal costs the must thus that holds . We should view the statements that a perfectly competitive market in the long run will feature both productive and with a degree of skepticism about its truth . Remember , economists are using the concept of in a particular and sense , not as a synonym for desirable in every For one thing , consumers ability to pay the income distribution in a particular society . For example , a person with a low income may not be able to purchase their own car because they have income . Perfect competition , in the long run , is a hypothetical benchmark . For market structures such as monopoly , monopolistic competition , and oligopoly , which are more frequently observed in the real world than perfect competition , will not always produce at the minimum of average cost , nor will they always set price equal to marginal cost . Thus , these other competitive situations will not produce productive and . Moreover , markets include many issues that are assumed away in the model of perfect competition , including pollution , inventions of new technology , poverty which may make some people unable to pay for basic necessities of life , government programs like national defense or education , discrimination in labor markets , and buyers and sellers who must deal with imperfect and unclear information . We explore these issues in other chapters . However , the theoretical of perfect competition does provide a useful benchmark for comparing the issues that arise from these problems . BRING IT HOME A Dime a Dozen A quick glance at Table reveals the dramatic increase in North Dakota corn a tenfold increase since 1972 . Recent allocation of land to corn ( as of ) is estimated to have increased to more than

208 Perfect Competition million acres . Taking into consideration that corn typically yields two to three times as many bushels per acre as wheat , it is obvious there has been a increase in bushels of corn . Why the increase in corn acreage ?

Converging prices . Year Corn ( millions of acres ) 1972 2013 TABLE ( Source National Agricultural Statistics Service ) Historically , wheat prices have been higher than corn prices , offsetting wheat lower yield per acre . However , in recent years wheat and corn prices have been converging . In April 2013 , reported the gap was just 71 cents per bushel . As the difference in price narrowed , switching to the production of higher yield per acre of corn simply made good business sense . Erik , president of the National Association of Wheat Growers said in the article , I do think we going to see mile after mile of waving amber of wheat anymore . Until wheat prices rise , we will probably be seeing after of corn . Access for free at

Key Terms 209 Key Terms break even point level of output where the marginal cost curve intersects the average cost curve at the minimum point of AC if the price is at this point , the is earning zero economic entry the process of entering an industry in response to industry exit the process of reducing production and shutting down in response to industry losses equilibrium where all earn zero economic producing the output level where and AC marginal revenue the additional revenue gained from selling one more unit market structure the conditions in an industry , such as number of sellers , how easy or it is for a new to enter , and the type that are sold perfect competition each faces many competitors that sell identical products price taker a in a perfectly competitive market that must take the prevailing market price as given shutdown point level of output where the marginal cost curve intersects the average variable cost curve at the minimum point of if the price is below this point , the should shut down immediately Key Concepts and Summary Perfect Competition and Why It Matters A perfectly competitive is a price taker , which means that it must accept the equilibrium price at which it sells goods . Ifa perfectly competitive attempts to charge even a tiny amount more than the market price , it will be unable to make any sales . In a perfectly competitive market there are thousands of sellers , easy entry , and identical products . A production period is when are producing with some inputs . equilibrium in a perfectly competitive industry occurs after all have entered and exited the industry and seller are driven to zero . Perfect competition means that there are many sellers , there is easy entry and exiting of , products are identical from one seller to another , and sellers are price takers . How Perfectly Competitive Firms Make Output Decisions As a perfectly competitive produces a greater quantity of output , its total revenue steadily increases at a constant rate determined by the given market price . will be highest ( or losses will be smallest ) at the quantity of output where total revenues exceed total costs by the greatest amount ( or where total revenues fall short of total costs by the smallest amount ) Alternatively , will be highest where marginal revenue , which is price for a perfectly competitive , is equal to marginal cost . If the market price faced by a perfectly competitive is above average cost at the quantity of output , then the is making . Ifthe market price is below average cost at the quantity of output , then the is making losses . If the market price is equal to average cost at the level of output , then the is making zero . We call the point where the marginal cost curve crosses the average cost curve , at the minimum of the average cost curve , the zero point . If the market price that a perfectly competitive faces is below average variable cost at the quantity , then the should shut down operations immediately . If the market price that a perfectly competitive faces is above average variable cost , but below average cost , then the should continue producing in the short run , but exit in the long run . We call the point where the marginal cost curve crosses the average variable cost curve the shutdown point . Entry and Exit Decisions in the Long Run In the long run , will respond to through a process of entry , where existing expand output and new enter the market . Conversely , will react to losses in the long run through a process of exit , in which existing cease production altogether . Through the process in response to and exit in response to losses , the price level in a perfectly competitive market will move toward the

210 Questions point , where the marginal cost curve crosses the AC curve at the minimum of the average cost curve . The supply curve shows the output supplied by in three different types of industries constant cost , increasing cost , and decreasing cost . Efficiency in Perfectly Competitive Markets equilibrium in perfectly competitive markets meets two important conditions and productive . These two conditions have important implications . First , resources are allocated to their best alternative use . Second , they provide the maximum satisfaction attainable by society . Questions . Firms in a perfectly competitive market are said to be price takers is , once the market determines an equilibrium price for the product , must accept this price . Ifyou sell a product in a perfectly competitive market , but you are not happy with its price , would you raise the price , even by a cent ?

Would independent trucking fit the characteristics ofa perfectly competitive industry ?

Look at Table . What would happen to the firms if the market price increases to per pack of raspberries ?

Quantity Fixed Cost Variable Cost Total Revenue 62 62 62 10 90 62 28 60 30 20 110 62 48 120 10 30 126 62 64 180 54 40 144 62 82 240 96 50 166 62 104 300 134 60 192 62 130 360 168 70 224 62 162 420 196 80 264 62 202 480 216 90 324 62 262 540 216 100 404 62 342 600 196 TABLE Access for free at

. 10 . Review Questions 211 Suppose that the market price increases to , as Table 814 shows . What would happen to the maximizing output level ?

Quantity Total Cost Fixed Cost Variable Cost Marginal Cost Total Revenue Marginal Revenue 62 62 10 90 62 28 60 20 110 62 48 120 30 126 62 64 180 40 144 62 82 240 50 166 62 104 300 60 192 62 130 360 70 224 62 162 420 80 264 62 202 480 90 324 62 262 540 100 404 62 342 600 TABLE Explain in words why a will not choose to produce at a quantity where marginal cost exceeds marginal revenue . A marginal cost curve above the average variable cost curve is equal to the individual supply curve . This means that every time a receives a price from the market it will be willing to supply the amount of output where the price equals marginal cost . What happens to the firms individual supply curve if marginal costs increase ?

If new technology in a perfectly competitive market brings about a substantial reduction in costs of production , how will this affect the market ?

A market in perfect competition is in equilibrium . What happens to the market if labor unions are able to increase wages for workers ?

Productive and are two concepts achieved in the long run in a perfectly competitive market . These are the two reasons why we call them How would you use these two concepts to analyze other market structures and label them imperfect ?

Explain how the rule of setting leads a perfectly competitive market to be efficient . Review Questions 11 . 12 . A single in a perfectly competitive market is relatively small compared to the rest of the market . What does this mean ?

How small is small ?

What are the four basic assumptions of perfect competition ?

Explain in words what they imply for a perfectly competitive .

212 Critical Thinking Questions 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . 22 . 23 . 24 . 25 . 26 . 27 . 28 . 29 . What is a price taker ?

How does a perfectly competitive decide what price to charge ?

What prevents a perfectly competitive from seeking higher by increasing the price that it charges ?

How does a perfectly competitive calculate total revenue ?

explain the reason for the shape ofa marginal revenue curve for a perfectly competitive . Wiat two rules does a perfectly competitive apply to determine its quantity of output ?

How does the average cost curve help to show whether a is making or losses ?

Wiat two lines on a cost curve diagram intersect at the point ?

Should a shut down immediately if it is making losses ?

How does the average variable cost curve help a know whether it should shut down immediately ?

Wiat two lines on a cost curve diagram intersect at the shutdown point ?

does entry occur ?

does exit occur ?

Do entry and exit occur in the short run , the long run , both , or neither ?

Wiat price will a perfectly competitive end up charging in the long run ?

Why ?

Will a perfectly competitive market display productive ?

Why or why not ?

Will a perfectly competitive market display ?

Why or why not ?

Critical Thinking Questions 30 . 31 . 32 . 33 . 34 . 35 . 36 . 37 . Finding a life partner is a complicated process that may take many years . It is hard to think of this process as being part ofa very complex market , with a demand and a supply for partners . Think about how this market works and some of its characteristics , such as search costs . Would you consider it a perfectly competitive market ?

Can you name examples competitive markets ?

Why or why not ?

Your company operates in a perfectly competitive market . You have been told that advertising can help you increase your sales in the short run . Would you create an aggressive advertising campaign for your product ?

Since a perfectly competitive can sell as much as it wishes at the market price , why can the not simply increase its by selling an extremely high quantity ?

Many in the United States for bankruptcy every year , yet they still continue operating . Why would they do this instead of completely shutting down ?

Why will for in a perfectly competitive industry tend to vanish in the long run ?

Why will losses for in a perfectly competitive industry tend to vanish in the long run ?

Assuming that the market for cigarettes is in perfect competition , what does and productive imply in this case ?

What does it not imply ?

Access for free at Problems 213 38 . In the argument for why perfect competition is , the price that people are willing to pay represents the gains to society and the marginal cost to the represents the costs to society . Can you think of some social costs or issues that are not included in the marginal cost to the ?

Or some social gains that are not included in what people pay for a good ?

Problems 39 . The Aquarium sells aquariums for 20 each . Fixed costs of production are 20 . The total variable costs are 20 for one aquarium , 25 for two units , 35 for the three units , 50 for four units , and 80 for units . In the form ofa table , calculate total revenue , marginal revenue , total cost , and marginal cost for each output level ( one to units ) What is the quantity of output ?

On one diagram , sketch the total revenue and total cost curves . On another diagram , sketch the marginal revenue and marginal cost curves . 40 . Perfectly competitive Doggies Paradise sells winter coats for dogs . Dog coats sell for 72 each . The costs are 100 . The total variable costs are 64 for one unit , 84 for two units , 114 for three units , 184 for four units , and 270 for units . In the form of a table , calculate total revenue , marginal revenue , total cost and marginal cost for each output level ( one to units ) On one diagram , sketch the total revenue and total cost curves . On another diagram , sketch the marginal revenue and marginal cost curves . What is the maximizing quantity ?

41 . A computer company produces affordable , home computer systems and has costs of 250 . The marginal cost computers is 700 for the computer , 250 for the second , 300 for the third , 350 for the fourth , 400 for the , 450 for the sixth , and 500 for the seventh . a . Create a table that shows the company output , total cost , marginal cost , average cost , variable cost , and average variable cost . At what price is the point ?

At what price is the shutdown point ?

If the company sells the computers for 500 , is it making a or a loss ?

How big is the or loss ?

Sketch a graph with AC , and curves to illustrate your answer and show the or loss . If the sells the computers for 300 , is it making a or a loss ?

How big is the or loss ?

Sketch a graph with AC , and curves to illustrate your answer and show the or loss .