Principles of Microeconomics Scarcity and Social Provisioning Chapter 11 Perfect Competition

CHAPTER 11 . PERFECT COMPETITION INTRODUCTION TO PERFECT COMPETITION Figure . Depending upon the competition and prices offered , a wheat farmer may choose to grow a different crop . Credit modification of work by Daniel Creative Commons ) 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 a lot of other competitors who offered identical services . There was nothing to stop others from offering their vices too . 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 . Growing a crop may be more difficult to start than a babysitting or lawn mowing service , but growers face the same fierce 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 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 Wheat .

PRINCIPLES or ECONOMICS 309 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 15 or so years has the mix of crops changed ?

Since it is relatively easy to switch crops , did farmers change what was planted as the relative crop prices changed ?

We will find 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 dozen . OB ( Introduction to Perfect Competition 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 Efficiency in Perfectly Competitive Markets 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 firms make decisions about how much to produce , how much profit 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 specific market , how easy or difficult it is for a new firm to enter , and the type of products that are sold . This is referred to as the market structure of the industry . In this chapter , we focus on perfect competition . However , in other chapters we will examine other industry types Monopoly and Monopolistic Competition and Oligopoly .

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 firms react in the short run and in the long run are said to be in perfect competition when the following conditions occur ( many firms 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 being bought and sold and ( firms can enter and leave the ket without any other words , there is free entry and exit into and out of the market . A perfectly competitive firm is known as a price taker , because the pressure of competing firms forces them to accept the prevailing equilibrium price in the market . If a firm in a perfectly tive market raises the price of its product by so much as a penny , it will lose all of its sales to . When a wheat grower , as discussed in the Bring it Home feature , wants to know what the going price of wheat is , he or she has to go to the computer or listen to the radio to check . The market price is determined solely by supply and demand in the entire market and not the individual farmer . Also , a perfectly competitive firm 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 tries do face many competitor firms selling highly similar goods , in which case they must often act as price takers . Agricultural markets are often used as an example . The same crops grown by ent farmers are largely interchangeable . According to the United States Department of Agriculture monthly reports , in 2015 , corn farmers received an average price of per bushel and wheat farmers received an average price of per bushel . A corn farmer who attempted to sell at per bushel , or a wheat grower who attempted to sell for per bushel , would not have found any buyers . A perfectly competitive firm will not sell below the equilibrium price either . Why should they when they can sell all they want at the higher price ?

Other examples of agricultural markets that ate in close to perfectly competitive markets are small roadside produce markets and small organic farmers . Visit this Website that reveals the current value of various commodities .

PRINCIPLES OF ECONOMICS 311 This chapter examines how firms decide how much to produce in perfectly markets . Such firms Will analyze their costs as discussed in the chapter on Cost and Industry Structure . In the short run , the perfectly competitive firm will seek the quantity of output where its are highest or , if profits are not possible , where losses are lowest . In this example , the short run refers to a situation in which firms are producing with one fixed input and incur fixed costs of duction . In the real world , firms can have many fixed inputs . In the long run , perfectly competitive firms Will react to profits by increasing production . They Will respond to losses by reducing production or exiting the market . Ultimately , a equilibrium Will be attained when no new firms want to enter the market and existing firms do not want to leave the market , as economic profits have been driven down to zero . KEY CONCEPTS AND SUMMARY A perfectly competitive firm is a price taker , which means that it must accept the equilibrium price at which it sells goods . If a perfectly competitive firm 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 sands of sellers , easy entry , and identical products . A production period is when firms are producing with some fixed inputs . equilibrium in a perfectly competitive industry occurs after all firms have entered and exited the industry and seller profits are driven to zero . Perfect competition means that there are many sellers , there is easy entry and exiting of firms , are identical from one seller to another , and sellers are price takers . SELF CHECK QUESTIONS . Firms in a perfectly competitive market are said to be price takers is , once the market determines an equilibrium price for the product , firms must accept this price . If you 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 of a perfectly competitive industry ?

REVIEW QUESTIONS . A single firm in a perfectly competitive market is relatively small compared to the rest of the market . What does this mean ?

How small is small ?

312 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER What are the four basic assumptions of perfect competition ?

Explain in Words What they imply for a perfectly competitive firm . What is a price taker firm ?

CRITICAL THINKING QUESTIONS Finding a life partner is a complicated process that may take many years . It is hard to think of this process as being part of a 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 five examples of perfectly competitive markets ?

Why or why not ?

market structure the conditions in an industry , such as number of sellers , how easy or difficult it is for a new firm to enter , and the type of products that are sold perfect competition each firm faces many competitors that sell identical products price taker a firm in a perfectly competitive market that must take the prevailing market price as given SOLUTIONS Answers to Questions . No , you would not raise the price . Your product is exactly the same as the product of the many other firms in the market . If your price is greater than that of your competitors , then your customers would switch to them and stop buying from you . You would lose all your sales . Possibly . Independent truckers are by definition small and numerous . All that is required to get into the business is a truck ( not an inexpensive asset , though ) and a commercial driver license . To exit , one need only sell the truck . All trucks are essentially the same , providing transportation from point A to point . We assuming we not talking about specialized trucks . Independent truckers must take the going rate for their service , so independent trucking does seem to have most of the characteristics of perfect competition .

HOW PERFECTLY COMPETITIVE FIRMS MAKE OUTPUT DECISIONS LEARNING OBJECTIVES By the end of this section , you will be able to Calculate profits by comparing total revenue and total cost Identify profits and losses with the average cost curve Explain the shutdown point Determine the price at which a firm should continue producing in the short run perfectly competitive firm has only one major decision to , what quantity to produce . To understand why this is so , consider a different way of writing out the basic of profit Profit Total revenue Total cost ( Quantity produced ) Average cost ) Quantity produced ) Since a perfectly competitive firm 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 profit equation , and so the perfectly competitive firm can sell any number of units at exactly the same price . It implies that the firm faces a perfectly elastic demand curve for its product buyers are willing to buy any number of units of output from the firm at the market price . When the perfectly firm chooses what quantity to produce , then this with the prices prevailing in the market for output and determine the firms total revenue , total costs , and ultimately , level of profits . DETERMINING THE HIGHEST PROFIT BY COMPARING TOTAL REVENUE AND TOTAL COST A perfectly competitive firm can sell as large a quantity as it Wishes , as long as it accepts the prevailing market price . Total revenue is going to increase as the firm sells more , depending on the price of the product and the number of units sold . If you increase the number of units sold at a given price , then total revenue will increase . If the price of the product increases for every unit sold , then total revenue also increases . As an example of how a perfectly competitive firm decides what quantity to produce , consider the case of a 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

314 on . If , for example , the price of frozen raspberries doubles to per pack , then sales of one pack of ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER raspberries will be , two packs will be 16 , three packs will be 24 , and so on . Total revenue and total costs for the raspberry farm , broken down into fixed and variable costs , are shown in Table and also appear in Figure . The horizontal axis shows the quantity of frozen berries produced in packs the vertical axis shows both total revenue and total costs , measured in lars . The total cost curve intersects with the vertical axis at a value that shows the level of fixed costs , and then slopes upward . All these cost curves follow the same characteristics as the curves covered in the Cost and Industry Structure chapter . Total Revenue ( Figure . Total Cost and Total Revenue at the Raspberry Farm . Total revenue for a perfectly competitive firm 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 profit will occur at 450 A 400 A 350 ' 300 I 250 ' 200 150 100 50 ' Loss Loss Total cost . MaxImum prom 56 Total , revenue . I ' I I 10 20 30 40 50 60 70 80 90 100 ( packs ot raspberries ) the quantity where the gap of total revenue over total cost is largest .

PRINCIPLES or ECONOMICS 315 Quantity Total Cost Fixed Cost Variable Cost Total Revenue ( 62 62 62 10 90 62 28 40 50 20 110 62 48 80 30 30 126 62 64 120 40 144 62 82 160 16 50 166 62 104 200 34 60 192 62 130 240 48 70 224 62 162 280 56 80 264 62 202 320 56 90 324 62 262 360 36 100 404 62 342 400 Table . Total Cost and Total Revenue at the Raspberry Farm Based on its total revenue and total cost curves , a perfectly competitive firm like the raspberry farm can calculate the quantity of output that will provide the highest level of profit . At any given quantity , total revenue minus total cost will equal profit . One way to determine the most profitable quantity to produce is to see at what quantity total revenue exceeds total cost by the largest amount . On Figure , the vertical gap between total revenue and total cost represents either profit ( if total revenues are greater that total costs at a certain quantity ) or losses ( if total costs are greater that total revenues at a certain quantity ) In this example , total costs will exceed total revenues at output levels from to 40 , and so over this range of output , the firm will be making losses . At output levels from 50 to 80 , total revenues exceed total costs , so the firm is earning profits . But then at an output of 90 or 100 , total costs again exceed total revenues and the firm is making losses . Total profits appear in the final of Table . The highest total profits in the table , as in the figure that is based on the table values , occur at an output of , when profits will be 56 . A higher price would mean that total revenue would be 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 firm can do is to suffer losses . But a firm will prefer the quantity of output where total come closest to total costs and thus where the losses are smallest . Later we will see that sometimes it will make sense for the firm to shutdown , rather than stay in ation producing output . COMPARING MARGINAL REVENUE AND MARGINAL COSTS 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 , firms experiment . They produce a slightly greater or lower quantity and observe how profits are affected . In economic terms , this

316 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER tical approach to maximizing profits means looking at 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 firm in perfect competition faces a perfectly elastic demand curve for its is , the firms demand curve is a horizontal line drawn at the market price level . This also means that the firms marginal revenue curve is the same as the firms demand curve Every time a consumer demands one more unit , the firm sells one more unit and revenue goes up by exactly the same amount equal to the market price . In this example , every time a pack of frozen raspberries is sold , the firms revenue increases by . Table shows an example of this . This condition only holds for price taking firms in perfect competition where marginal revenue price The formula for marginal revenue is , change in total revenue revenue change Price Quantity 12 16 Table . Marginal Revenue Notice that marginal revenue does not change as the firm produces more output . That is because the price is determined by supply and demand and does not change as the farmer produces more ( keeping in mind that , due to the relative small size of each firm , increasing their supply has no impact on the total market supply where price is determined ) Since a perfectly competitive firm is a price taker , it can sell whatever quantity it wishes at the determined price . Marginal cost , the cost per additional unit sold , is calculated by dividing the change in total cost by the change in quantity . The formula for marginal cost is , change in total cost cost change In Ordinarily , marginal cost changes as the firm produces a greater quantity . In the raspberry farm example , shown in Figure , Figure and Table , marginal cost at first declines as production increases from 10 to 20 to 30 packs of represents the area of increasing marginal returns that is not uncommon at low levels of production . But then marginal costs start to increase , displaying the typical pattern of diminishing marginal returns . If the firm is producing at a quantity where , like 40 or 50 packs of raspberries , then it can increase profit by increasing output because the marginal revenue is exceeding the marginal cost . If the firm is at a quantity where , like 90 or 100 packs , then it can increase profit by reducing

PRINCIPLES or ECONOMICS 317 output because the reductions in marginal cost Will exceed the reductions in marginal revenue . The firms choice of output will occur where ( or at a choice close to that point ) You will notice that What occurs on the production side is exemplified on the cost side . This is referred to as duality . cost 70 maxImIzIng ' I I revenue Marginal Revenue ( I I I 10 20 30 40 50 60 70 80 90 100 Quantity ( packs of raspberries ) Figure . Marginal Revenues and Marginal Costs at the Raspberry Farm Individual Farmer . For a perfectly competitive firm , the marginal revenue ( curve is a horizontal straight line because it is equal to the price of the good , which is determined by the market , shown in Figure . The marginal cost ( curve is sometimes first , if 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 . Quantity Total Cost Fixed Cost Variable Cost Marginal Cost Total Revenue Marginal Revenue 62 62 10 90 62 28 280 40 20 110 62 48 200 80 30 126 62 64 160 120 40 144 62 82 180 160 50 166 62 104 2120 200 60 192 62 130 2160 240 70 224 62 162 3120 280 80 264 62 202 4100 320 90 324 62 262 6100 360 100 404 62 342 8100 400 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 and a quantity of 80 produced . If the farmer started out producing at a level of 60 , and then experimented with

313 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER A I GE Supply Demand 80 Quantity ( packs of raspberries ) Figure . Marginal Revenues and Marginal Costs at the Raspberry Farm Raspberry Market . The equilibrium price of raspberries is determined through the interaction of market supply and market demand at . increasing production to 70 , marginal revenues from the increase in production would exceed so profits would rise . The farmer has an incentive to keep producing . From a level of 70 to 80 , marginal cost and marginal revenue are equal so profit doesn change . If the farmer then experimented further with increasing production from 80 to 90 , he would find that marginal costs from the increase in production are greater than marginal revenues , and so profits would decline . The choice for a perfectly competitive firm will occur where marginal revenue is equal to marginal is , where . A firm should keep expanding duction as long as . But at the level of output where , the firm should recognize that it has achieved the highest possible level of economic profits . In the example above , the profit maximizing output level is between 70 and 80 units of output , but the firm will not know they ve maximized profit until they reach 80 , where . Expanding production into the zone where will only reduce economic profits . Because the marginal revenue received by a perfectly competitive firm is equal to the price , so that , the rule for a perfectly competitive firm can also be written as a recommendation to produce at the quantity where . PROFITS AND LOSSES WITH THE AVERAGE COST CURVE Does maximizing profit ( producing where ) imply an actual economic profit ?

The answer depends on the relationship between price and average total cost . If the price that a firm charges is higher than its average cost of production for that quantity produced , then the firm will earn profits . Conversely , if the price that a firm charges is lower than its average cost of production , the firm will suffer losses . You might think that , in this situation , the farmer may want to shut down immediately . Remember , however , that the firm has already paid for fixed costs , such as equipment , so it may to produce and incur a loss . Figure illustrates three situations ( a ) where price intersects cost at a level above the average cost curve , where price intersects marginal cost at a level

PRINCIPLES OF ECONOMICS 319 equal to the average cost curve , and ( where price intersects marginal cost at a level below the age cost curve . a cu cost Marginal cost I Average cost Average cost I A I I ) revenue If , A . revenue I ' I I ' I I 10 20 30 40 50 60 70 80 90100 10 20 30 40 50 60 70 80 90100 Quantity ( packs of raspberries ) a ) IS above average cost Marginal Reven ue ( Price equals cost I I I I revenue II iI II 20 30 40 50 60 70 80 90100 Quantity ( packs of raspberries ) PrIce Is below average cost Quantity ( packs of raspberries ) 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 firm is making a profit . In ( price intersects marginal cost at the minimum point of the average cost curve . Since price is equal to average cost , the firm 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 perfectly competitive firm is to produce the level of output where Price , so the raspberry farmer will produce a quantity of 90 , 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 large shaded rectangle from the origin over to a quantity of 90 packs ( the base ) up to point ( the height ) over to the price of , and back to the origin . The

320 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER average cost of producing 80 packs is shown by point or about . Total costs will be the of 80 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 . It should be clear from examining the two rectangles that total revenue is greater than total cost . Thus , profits will be the blue shaded rectangle on top . It can be calculated as profit total revenue total cost ( 90 ) 90 ) 135 Or , it can be calculated as profit ( price average cost ) quantity ( 500 350 ) 90 135 Now consider Figure ( where the price has fallen to for a pack of frozen raspberries . Again , the perfectly competitive firm will choose the level of output where Price , but in this case , the quantity produced will be 70 . At this price and output level , where the marginal cost curve is crossing the average cost curve , the price received by the firm is exactly equal to its average cost of production . The farm total revenue at this price will be shown by the large shaded rectangle from the origin over to a quantity of 70 packs ( the base ) up to point ( the height ) over to the price of , and back to the origin . The average cost of producing 70 packs is shown by point . Total costs will be the quantity of 70 times the average cost of , which is shown by the area of the rectangle from the origin to a quantity of 70 , up to point , over to the vertical axis and down to the origin . It should be clear from that the rectangles for total revenue and total cost are the same . Thus , the firm is making zero profit . The calculations are as follows profit total revenue total cost ( 70 ) 70 ) Or , it can be calculated as

PRINCIPLES or ECONOMICS 321 profit ( price average cost ) quantity ( 70 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 50 . The farm total revenue at this price will be shown by the large shaded rectangle from the origin over to a quantity of 50 packs ( the base ) up to point ( the height ) over to the price of , and back to the origin . The average cost of producing 50 packs is shown by point or about . Total costs will be the quantity of 50 times the average cost of , which is shown by 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 . It should be clear from examining the two rectangles that total revenue is less than total cost . Thus , the firm is losing money and the loss ( or negative profit ) will be the rectangle . The calculations are profit total revenue total cost ( 50 ) 50 ) Or profit ( price average cost ) quantity ( 50 If the market price received by a perfectly competitive firm leads it to produce at a quantity where the price is greater than average cost , the firm will earn profits . If the price received by the firm causes it to produce at a quantity where price equals average cost , which occurs at the minimum point of the AC curve , then the firm earns zero profits . Finally , if the price received by the firm leads it to produce at a quantity where the price is less than average cost , the firm will earn losses . This is summarized in Table . If Then Price ATC Firm earns an economic profit Price ATC Firm earns zero economic profit Price ATC Firm earns a loss Table .

322 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER THE SHUTDOWN POINT The possibility that a firm may earn losses raises a question Why can the firm 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 firm has already paid for fixed costs . As a result , if the firm produces a quantity of zero , it would still make losses because it would still need to pay for its fixed costs . So , when a firm 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 . If the firm decides to operate , its marginal costs for hiring yoga ers is for the month . If the firm shuts down , it must still pay the rent , but it would not need to hire labor . Table shows three possible scenarios . In the first 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 fixed costs . In the second scenario , the Yoga Center has clients that earn the center 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 firm should exit this business . In the short run , though , the decision varies depending on the level of losses and whether the firm can cover its able 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 fixed costs . In scenario , the losses are greater because it does not make enough revenue to offset the increased variable costs plus fixed costs , so it should shut down immediately . If price is below the minimum average variable cost , the firm 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 .

PRINCIPLES or ECONOMICS 323 Scenario If the center shuts down now , revenues are zero but it will not incur any variable costs and would only need to pay fixed costs of . profit total revenue ( 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 ) 000 Table . Should the Yoga Center Shut Down Now or Later ?

This example suggests that the key factor is whether a firm can earn enough revenues to cover at least its variable costs by remaining open . Let return now to our raspberry farm . Figure illustrates this lesson by adding the average variable cost curve to the marginal cost and average cost curves . At a price of per pack , as shown in Figure ( a ) the farm produces at a level of 50 . It is making losses of 56 ( as explained earlier ) but price is above average variable cost and so the firm continues to ate . However , if the price declined to per pack , as shown in Figure ( and if the firm applied its rule of producing where , it would produce a quantity of 40 . This price is below age variable cost for this level of output . If the farmer can not pay workers ( the variable costs ) then it has to shut down . At this price and output , total revenues would be 72 ( quantity of 40 times price of ) and total cost would be 144 , for overall losses of 72 . If the farm shuts down , it must pay only its fixed costs of 62 , so shutting down is preferable to selling at a price of per pack . Looking at Table , if the price falls below , the minimum average variable cost , the firm must shut down .

324 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER 23 , Marginal cost COS Marginal Co , I . Ir a , A , 77 ' Average I ! palm ( 40 , 80 ) 13 cost I . 10 20 30 40 50 60 70 80 90100 20 30 40 50 60 70 80 90100 Quantity ( packs of raspberries ) Quantity ( packs of raspberries ) a ) IS above average cost ( Is below average cost Figure . The Shutdown Point for the Raspberry Farm . In ( a ) the farm produces at a level of 50 . It is making losses of 56 , but price is above average variable cost , so it continues to operate . In ( total revenues are 72 and total cost is 144 , for overall losses of 72 . If the farm shuts down , it must pay only its fixed costs of 62 . Shutting down is preferable to selling at a price of per pack . Quantity Total Cost Fixed Cost Variable Cost Marginal Cost Average Cost Average Variable Cost 62 62 10 90 62 28 20 110 62 48 30 126 62 64 40 144 62 82 50 166 62 104 60 192 62 130 70 224 62 162 80 264 62 202 90 324 62 262 100 404 62 342 Table . Cost of Production for the Raspberry Farm The intersection of the average variable cost curve and the marginal cost curve , which shows the price where the firm would lack enough revenue to cover its variable costs , is called the shutdown point . If the perfectly competitive firm can charge a price above the shutdown point , then the firm is at least covering its average variable costs . It is also making enough revenue to cover at least a portion of fixed 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 firm shuts down immediately and incurs a loss equal to total fixed costs . ever , if the firm is receiving a price below the price at the shutdown point , then the firm is not even covering its variable costs . In this case , staying open is making the firms losses larger , and it should shut down immediately . To summarize , if

PRINCIPLES OF ECONOMICS 325 price minimum average variable cost , then firm shuts down price minimum average variable cost , then firm 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 shown in Figure . At the market price , which the perfectly competitive firm accepts as given , the firm chooses the output level where price or marginal revenue , which are the same thing for a perfectly competitive firm , is equal to marginal cost . zone AC , Shutdown , Loss but In ZONE Shutdown zone Output Figure . Profit , Loss , Shutdown . The marginal cost curve can be divided into three zones , based on where it is crossed by the average cost and average variable cost curves . The point where crosses AC is called the point . If the firm is operating at a level of output where the market price is at a level higher than the point , then price will be greater than average cost and the firm is earning profits . If the price is exactly at the point , then the firm is making zero profits . If price falls in the zone between the shutdown point and the point , then the firm is making losses but will continue to operate in the short run , since it is covering its variable costs . 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 profit point . At any price above that level , the firm will earn profits in the short run . If the price falls exactly on the zero profit point where the and AC curves cross , then the firm earns zero profits . If a price falls into the zone between the zero profit point , where crosses AC , and the shutdown point , where crosses , the firm will be making losses in the

326 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER short since the firm is more than covering its variable costs , the losses are smaller than if the firm shut down immediately . Finally , consider a price at or below the shutdown point where crosses . At any price like this one , the firm will shut down immediately , because it can not even cover its variable costs . MARGINAL COST AND THE FIRM SUPPLY CURVE For a perfectly competitive firm , the marginal cost curve is identical to the firm supply curve starting from the minimum point on the average variable cost curve . To understand why this perhaps insight holds true , first think about what the supply curve means . A firm 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 firm will maximize its profits by producing at the quantity where . This rule means that the firm 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 firms supply curve . Watch this video that addresses how drought in the United States can impact food prices across the world . Note that the story on the drought is the second one in the news report you need to let the video play through the first story in order to watch the story on the drought . As 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 ment regulations can add to costs of certain goods in a way that causes supply to shift to the left . These shifts in the firm supply curve can also be interpreted as shifts of the marginal cost curve . A shift in costs of production that increases marginal costs at all levels of shifts to the cause a perfectly competitive firm 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 to the right and as a result , a competitive firm 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 of a firm in perfect competition , follow the steps outlined below . Use the data shown in Table .

PRINCIPLES OF ECONOMICS 327 ATC Profits 28 20 28 20 20 28 20 25 28 20 35 28 20 52 Table . Step . Determine the cost structure for the firm . For a given total fixed costs and variable costs , total cost , average variable cost , average total cost , and marginal cost . Follow the formulas given in the Cost and Industry Structure chapter . These calculations are shown in Table . ATC ( 28 20 20 ( 28 20 20 40 ( 20 ( 28 20 25 45 ( 45 ) 28 20 35 55 ( 10 ( 55 ) 28 20 52 72 ( 17 ( 72 ) 28 20 80 ( 28 Table . Step . Determine the market price that the firm receives for its product . This should be given , as the firm in perfect competition is a price taker . 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 30 . You can see that in the second column of Table .

328 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER 75 28 56 84 112 140 Table . 28 28 28 28 28 28 Step . Calculate profits as total cost subtracted from total revenue , as shown in Table 10 . Quantity Total Cost ( Table 10 . 28 56 84 112 140 20 40 45 55 72 100 20 12 11 29 40 40 Step . To find the output level , look at the Marginal Cost column ( at every output level produced ) as shown in Table , and determine where it is equal to the market price . The output level where price equals the marginal cost is the output level that maximizes profits . Table 11 . 28 28 28 28 28 28 20 20 20 20 40 20100 20 25 45 12150 20 35 55 11167 20 52 72 13100 20 80 100 1640 ATC 20 10 17 30 28 56 84 112 140 Profits 20 29 40 40 Step . Once you have determined the output level ( in this case , output quantity ) you can look at the amount of profits made ( in this case , 40 ) Step . If the firm is making economic losses , the firm 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 fixed 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 .

PRINCIPLES OF ECONOMICS 329 If but ATC , then the firm continues to produce in the , making economic losses . If , then the firm stops producing and only incurs its fixed costs . In this example , the price of 28 is greater than the ( of producing units of output , so the firm continues producing . KEY CONCEPTS AND SUMMARY As a perfectly competitive firm produces a greater quantity of output , its total revenue steadily increases at a constant rate determined by the given market price . Profits 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 , profits will be highest where marginal revenue , which is price for a perfectly competitive firm , is equal to marginal cost . If the market price faced by a perfectly competitive firm is above average cost at the quantity of output , then the firm is making profits . If the market price is below average cost at the quantity of output , then the firm is making losses . If the market price is equal to average cost at the level of output , then the firm is making zero profits . The point where the marginal cost curve crosses the average cost curve , at the minimum of the average cost curve , is called the zero profit If the market price faced by a perfectly competitive firm is below average variable cost at the quantity of put , then the firm should shut down operations immediately . If the market price faced by a perfectly competitive firm is above average variable cost , but below average cost , then the firm should continue producing in the short run , but exit in the long run . The point where the marginal cost curve crosses the average variable cost curve is called the shutdown point . SELF CHECK QUESTIONS . Look at Table 12 . What would happen to the firm profits if the market price increases to per pack of raspberries ?

Quantity Fixed Cast Profit 62 62 62 10 90 62 23 60 30 20 110 62 43 120 10 30 126 62 64 130 54 40 144 62 32 240 96 50 166 62 104 300 134 60 192 62 130 360 163 70 224 62 162 420 196 80 264 62 202 430 216 90 324 62 262 540 216 100 404 62 342 600 196 330 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER . Suppose that the market price increases to , as shown in Table 13 . 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 20 10 62 30 126 62 40 144 62 50 166 62 60 192 62 70 224 62 80 264 62 90 324 62 100 404 62 Table 13 . Explain in words why a firm will not choose to produce at a quantity where marginal cost exceeds marginal revenue . A firm marginal cost curve above the average variable cost curve is equal to the firm individual supply curve . This means that every time a firm 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 firm individual supply curve if marginal costs increase ?

REVIEW QUESTIONS How does a perfectly competitive firm decide What price to charge ?

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

How does a perfectly competitive firm calculate total revenue ?

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

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

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

Should a firm shut down immediately if it is making losses ?

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

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

331 PRINCIPLES OF ECONOMICS CRITICAL THINKING QUESTIONS . 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 firm can sell as much as it wishes at the market price , why can the firm not simply increase its profits by selling an extremely high quantity ?

PROBLEMS . The 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 five units . In the form of a table , calculate total revenue , marginal revenue , total cost , and marginal cost for each output level ( one to five 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 . Perfectly competitive firm Doggies Paradise sells Winter coats for dogs . Dog coats sell for 72 each . The fixed costs of production are 100 . The total variable costs are 64 for one unit , 84 for two units , 14 for three units , 184 for four units , and 270 for five units . In the form of a table , calculate total revenue , marginal revenue , total cost and marginal cost for each output level ( one to five 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 profit maximizing quantity ?

A computer company produces affordable , home computer systems and has fixed costs of 250 . The marginal cost of producing computers is 700 for the first computer , 250 for the second , 300 for the third , 350 for the fourth , 400 for the fifth , 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 profit or a loss ?

How big is the profit or loss ?

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

How big is the profit or loss ?

Sketch a graph with AC , and curves to illustrate your answer and show the profit or loss . marginal revenue the additional revenue gained from selling one more unit 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 firm should shut down immediately

332 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Answers to Questions Holding total cost constant , profits at every output level would increase . When the market price increases , marginal revenue increases . The firm would then increase production up to the point Where the new price equals marginal cost , at a quantity of 90 . If marginal costs exceeds marginal revenue , then the firm will reduce its profits for every additional unit of output it produces . Profit would be greatest if it reduces output to Where . The firm will be Willing to supply fewer units at every price level . In other words , the firm individual supply curve decreases and shifts to the left .

ENTRY AND EXIT DECISIONS IN THE LONG RUN LEARNING By the end of this section , you will be able to Explain how entry and exit lead to zero profits in the long run Discuss the adjustment process he line between the short run and the long run can not be defined precisely with a stopwatch , or even with a calendar . It varies according to the specific business . The distinction between the short run and the long run is therefore more technical in the short run , firms can not change the usage of fixed inputs , while in the long run , the firm can adjust all factors of production . In a competitive market , profits are a red cape that incites businesses to charge . If a business is making a profit in the short run , it has an incentive to expand existing factories or to build new ones . New firms may start production , as well . When new firms enter the industry in response to increased industry profits it is called entry . Losses are the black thundercloud that causes businesses to . If a business is making losses in the short run , it will either keep limping along or just shut down , depending on whether its revenues are covering its variable costs . But in the long run , firms that are facing losses will shut down at least some of their output , and some firms will cease production altogether . The process of reducing production in response to a sustained pattern of losses is called exit . The following Clear It Up ture discusses where some of these losses might come from , and the reasons why some firms go out of business . WHY DO FIRMS CEASE TO EXIST ?

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

Profits are the measurement that determines Whether a business stays operating or not . Individuals start businesses with the purpose of making profits . 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 adventure must eventually end . In the model of perfectly competitive firms , 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 US . Small Business Administration indicates that in 2011 , new firms entered , and firms failed .

334 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER 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 that might best be summarized as bad luck . For example , conditions of demand and supply in the market shift in an unexpected way , so that the prices that can be charged for outputs fall or the prices that need to be paid for inputs rise . With millions of businesses in the US . economy , even a small fraction of them failing will affect many business failures can be very hard on the Workers and managers directly involved . But from the standpoint of the overall economic system , business exits are sometimes a evil if a system is going to offer a 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 firm acting alone can affect the market price . However , the combination of many firms 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 age total costs so that all firms are earning a zero profit . To understand how profits for a perfectly competitive firm will evaporate in the long run , imagine the following situation . The market is in equilibrium , where all firms earn zero economic profits producing the output level where and AC . No firm has the tive to enter or leave the market . Lets say that the products demand increases , and with that , the ket price goes up . The existing firms 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 average cost curve , and therefore , the existing firms in the market will now be earning economic profits . However , these economic profits attract other firms to enter the market . Entry of many new firms 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 profits fall for new and existing firms . As long as there are still profits 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 firm is earning economic profits . losses will fade away by reversing this process . Say that the market is in . This time , instead , demand decreases , and with that , the market price starts falling . The existing firms 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 firms will continue producing where the new , as long as they are able to cover their average variable costs . Some firms will have to shut down immediately as they will not be able to cover their average variable costs , and will then only incur their fixed costs , minimizing their losses . Exit of many firms causes the market supply curve to shift to the left . As the supply curve shifts to the left , the market price starts rising , and nomic losses start to be lower . This process ends whenever the market price rises to the level , where the existing firms are no longer losing money and are at zero profits again . Thus , while a perfectly competitive firm can earn profits in the short run , in the long run the process of entry will push down prices until they reach the level . Conversely , while a perfectly competitive firm may earn losses in the short run , firms will not continually lose money . In the long run , firms ing losses are able to escape from their fixed 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

PRINCIPLES or ECONOMICS 335 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 firms could either stay the same , increase , or even decrease . Therefore , we can categorize an industry as being ( a constant cost industry ( as demand increases , the cost of production for firms stays the same ) an increasing cost industry ( as demand increases , the cost of production for firms increases ) or ( a decreasing cost industry ( as demand increases the costs of production for the firms decreases ) For a constant cost industry , whenever there is an increase in market demand and price , then the supply curve shifts to the right with new firms entry and stops at the point where the new equilibrium intersects at the same market price as before . But 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 , 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 constant cost industries . For an increasing cost industry , as the market expands , the old and new firms experience increases in their 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 rise , wages rise and this increases the cost of production for all firms . 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 firms 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 firms 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 . High tech industries may be a good example of a decreasing cost market . Figure ( a ) presents the case of an adjustment process in a constant cost 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 we join 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 . KEY CONCEPTS AND SUMMARY In the long run , firms will respond to profits through a process of entry , where existing firms expand output and new firms enter the market . Conversely , firms will react to losses in the long run through a process of exit , in which existing firms reduce output or cease production altogether . Through the process of entry in response to profits and exit in response to losses , the price level in a perfectly

336 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Price Price Price Quantity ( a ) Constant cost ( cost ( Decreasing cost Figure . Adjustment Process in a 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 . market will move toward the 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 firms in three different types of industries constant cost , increasing cost , and decreasing cost . SELF CHECK QUESTIONS . 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 ?

REVIEW QUESTIONS Why does entry occur ?

Why does exit occur ?

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

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

Why ?

PRINCIPLES OF ECONOMICS 337 CRITICAL THINKING QUESTIONS Many firms in the United States file for bankruptcy every year , yet they still continue operating . Why would they do this instead of completely shutting down ?

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

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

entry the process of firms entering an industry in response to industry profits exit the process of firms reducing production and shutting down in response to industry losses equilibrium where all firms earn zero economic profits producing the output level Where SOLUTIONS Answers to Questions . With a technological improvement that brings about a reduction in costs of production , an adjustment process will take place in the market . The technological improvement will result in an increase in supply curves , by individual firms and at the market level . The existing firms will experience higher profits for a While , which will attract other firms into the market This entry process will stop whenever the market supply increases enough ( both by existing and new firms ) so profits are driven back to zero . When wages increase , costs of production increase . Some firms would now be making economic losses and would shut down . The supply curve then starts shifting to the left , pushing the market price up . This process ends when all firms remaining in the market earn zero economic profits . The result is a contraction in the output produced in the market

EFFICIENCY IN PERFECTLY COMPETITIVE MARKETS LEARNING OBJECTIVES By the end of this section , you will be able to Apply concepts of productive efficiency and efficiency to perfectly competitive markets Compare the model of perfect competition to markets hen firms in perfectly competitive markets combine with consumers , something remarkable happens the resulting quantities of outputs of goods and services demonstrate both productive and efficiency ( terms that were first introduced in ( Choice in a World of Scarcity ) Productive efficiency means producing without waste , so that the choice is on the production 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 , goods are being produced and sold at the lowest possible average cost . efficiency means that among the points on the production possibility frontier , the point that is chosen is socially least in a particular and specific sense . In a perfectly tive market , price will be equal to the marginal cost of production . Think about the price that is paid for a good as a measure of the social benefit received for that good after all , willingness to pay what the good is worth to a buyer . Then think about the marginal cost of producing the good as representing not just the cost for the firm , but more broadly as the social cost of producing that good . When perfectly competitive firms follow the rule that profits are maximized by producing at the quantity where price is equal to marginal cost , they are thus ensuring that the social benefits received from producing a good are in line with the social costs of production . To explore what is meant by efficiency , it is useful to walk through an example . Begin by assuming that the market for wholesale is perfectly competitive , and so . Now , sider what it would mean if firms 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 benefit 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 .

PRINCIPLES or ECONOMICS 339 Conversely , consider what it would mean if , compared to the level of output at the choice when , firms produced a greater quantity of . At a greater quantity , costs of production will have increased so that . In that case , the marginal costs of producing additional is greater than the benefit to society as measured by what people are willing to pay . For society as a whole , since the costs are outstripping the benefits , it will make sense to produce a lower quantity of such goods . When perfectly competitive firms maximize their profits by producing the quantity where , they also assure that the benefits 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 firm must thus that efficiency holds . The statements that a perfectly competitive market in the long run will feature both productive and efficiency do need to be taken with a few grains of salt . Remember , economists are using the concept of efficiency in a particular and specific sense , not as a synonym for desirable in every For one thing , consumers ability to pay reflects the income distribution in a particular society . Thus , a homeless person may have no ability to pay for housing because they have insufficient 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 , firms 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 productive and efficiency . 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 ple 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 . These issues are explored in other chapters . However , the theoretical efficiency of competition does provide a useful benchmark for comparing the issues that arise from these world problems . A DIME A DOZEN A quick glance at Table 14 reveals the dramatic increase in North Dakota corn than double . 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 significant increase in bushels of corn . Why the increase in corn acreage ?

Converging prices . Year Corn ( millions of acres ) Wheat ( millions of acres ) 2014 Table 14 . 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 re going to see mile after mile of waving amber fields of wheat anymore . Until wheat prices rise , we will probably be seeing field after field of corn .

340 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER KEY CONCEPTS AND SUMMARY equilibrium in perfectly competitive markets meets two important conditions efficiency and productive efficiency . These two conditions have important implications . First , resources are allocated to their best alternative use . Second , they provide the maximum satisfaction attainable by society . SELF CHECK QUESTIONS . Productive efficiency and efficiency are two concepts achieved in the long run in a perfectly competitive market . These are the two reasons Why We call them perfect . 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 . Will a perfectly competitive market display productive efficiency ?

Why or why not ?

Will a perfectly competitive market display efficiency ?

Why or why not ?

CRITICAL THINKING QUESTIONS . Assuming that the market for cigarettes is in perfect competition , what does and productive efficiency imply in this case ?

What does it not imply ?

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

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

REFERENCES Index Mundi . Wheat Monthly . Dollars per Metric Accessed March 11 , Wheat on the Defensive in the Northern , Associated Press State Wire North Dakota ( April 14 , 2013 . Office of Advocacy . 2014 . Frequently Asked Questions Advocacy the voice of small business in Accessed March 11 ,

PRINCIPLES OF ECONOMICS 341 Answers to Questions Perfect competition is considered to be perfect because both and productive efficiency are met at the same time in a equilibrium . If a market structure results in equilibrium that does not minimize average total costs or does not charge a price equal to marginal cost , then either or productive ( or both ) efficiencies are not met , and therefore the market can not be labeled perfect . Think of the market price as representing the gain to society from a purchase , since it represents what someone is willing to pay . Think of the marginal cost as representing the cost to society from making the last unit of a good . If , then the benefits from producing more of a good exceed the costs , and society would gain from producing more of the good . If , then the social costs of producing the marginal good exceed the social benefits , and society should produce less of the good . Only if , the rule applied by a perfectly competitive firm , will society costs and benefits be in balance . This choice will be the option that brings the greatest overall benefit to society .