Week7.PerfectCompetition.2009

Week7.PerfectCompetition.2009 - Week 7 Perfect Competition...

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1 Week 7 – Perfect Competition Perfect Competition – the main model for microeconomics - the firm in SR - the industry in SR - the firm in LR - the industry in LR - the dynamics of SR and LR adjustments to a “shock” – how does equilibrium change in SR and LR - too much material to complete in one week, but included here because it is all one model.
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2 Perfect Competition 1. Many buyers, many sellers (price takers) 2. Homogeneous good…standardized (no brand loyalty) 3. Free entry and exit (no barriers to competition) 4. Perfect information (consumers do not make mistakes…always find the lowest price)
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3 Typical cost situation facing perfectly competitive firm: Rising MC in SR because of diminishing marginal product of labour (note that TC = (P L L) + (P K K), so that dTC/dL = P L Also, we can write the marginal product of labour as MP L = dq/dL [where q = f(K, L)]. Therefore, the ratio P L /MP L = (dTC/dL)/(dq/dL) or dTC/dL dL/dq = dTC/dq In other words: MC = P L /MP L !) U-shaped AVC and AC curves AFC declining as output increases Look like diagram on next page…
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4 0 AVC MC Cost per unit quantity Quantity produced per unit of time AC AFC
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5 Simplified a bit… 0 AVC MC Cost per unit quantity Quantity produced per unit of time AC
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6 Remember, cost curves (and cost functions) in economics include all opportunity costs…including those that accountants don’t count (a normal return on money invested in the firm, labour of family members and of the owner, etc.)
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7 PC firm will try to maximize profit. It can’t change its cost curves. It can’t push up the price. It can’t distinguish its product from others by advertising/marketing/product innovation. All it can do is choose the profit-maximizing output! Π = TR – TC Max q Π = dTR/dq = dTC/dq = 0 i.e., MR – MC = 0 or MR = MC i.e., choose the output at which MR = MC
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8 Because individual PC firm has no power over price, D curve is horizontal (perfectly elastic).
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