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Perfect Competition

Learn about the concept of perfect competition and its important features. Discover how firms in perfectly competitive markets become price takers and maximize their profits through short-run output decisions. Explore the relationship between short-run profit maximization and market equilibrium.

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Perfect Competition

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  1. Perfect Competition • These slides supplement the textbook, but should not replace reading the textbook

  2. What ismarket structure? • Important features of a market, such as the number of firms, product uniformity, ease of entry, and forms of competition

  3. What are the four types of Markets? • Perfect Competition • Monopolistic Competition • Oligopoly • Monopoly

  4. What is aperfectly competitive market? • homogeneous product • many buyers and sellers • no one has much market power • easy entry & easy exit • can sell all bring to market

  5. What is a price taker? • A firm that faces a given market price and whose actions have no effect on that market price

  6. Why is a firm that is part of a perfectly competitive market a price taker? • Because if the firm charges higher than the market price it will not sell even one unit

  7. Market Equilibrium in Perfect Competition • S • Surplus • Price per unit • Shortage • D • 0 • Quantity per period • Exhibit 1a

  8. The Firm’s Demand Curve in Perfect Competition • P • P • S • d • D • Individual quantity • Market quantity • 8

  9. How does the firm maximize profit? • By finding the rate of output that makes total revenue minus total cost as large as possible

  10. Short-Run Profit Maximization • Panel A: TR minus TC • TC • TR • $60 • Maximum economic profit = $12 • 48 • Total dollars • 15 • 0 • 5 • 7 • 10 • 12 • 15 • Quantity per period • Exhibit 3a

  11. What is marginal revenue? • The change in total revenue resulting from a one-unit change in sales

  12. What is marginal cost? • The change in total cost resulting from a one-unit change in sales

  13. At what point are profits maximized? • At the level of output where MR = MC, or the last unit of output where MR > MC

  14. Maximizing Profits in the Short-Run • Q MR TR TC MC ATC Profit • 10 5 50 40.00 2.75 4.00 10.00 11 5 55 43.25 3.25 3.93 11.7512 5 60 48.00 4.75 4.00 12.0013 5 65 54.50 6.50 4.19 10.5014 5 70 64.00 9.50 4.57 6.00 • Exhibit 2

  15. Why does MR = P in Perfect Competition? • Because no matter how many units are brought to market, the firm can sell all of them at the market price

  16. What isaverage revenue? • Total revenue divided by output • TR / Q

  17. Why does AR=P in all markets? • Because each unit is sold for the same price at one point in time

  18. Short-Run Profit Maximization • Panel B: MR equals MC • MC • ATC • e • d = MR = AR • $5 • a • Total dollars • $4 • Profit • 0 • 12 • Quantity per period • Exhibit 3b

  19. At what point are losses minimized? • At the level of output where MR = MC, or the last unit of output where MR > MC

  20. Minimizing Losses in the Short-Run • Q MR TR TC MC ATC Loss • 8 3 24 35.25 1.50 4.41 -11.25 9 3 27 37.25 2.00 4.14 -10.2510 3 30 40.00 2.75 4.00 -10.0011 3 33 43.25 3.25 3.93 -10.2512 3 36 48.00 4.75 4.00 -12.00 • Exhibit 4

  21. What will a firm do if average variable cost exceeds price at every level of production? • Shut down

  22. Minimizing Short-Run Losses • Panel A: TC and TR • TC • TR • $40 • Total dollars • 30 • Minimum economic loss = $10 • 15 • 0 • 5 • 10 • 15 • Quantity per period • Exhibit 5a

  23. Minimizing Short-Run Losses • Panel B: MC equals MR • MC • ATC • $4.00 • AVC • Loss • Dollars per unit • 3.00 • 2.50 • d = MR = AR • 0 • 5 • 10 • 15 • Quantity per period • Exhibit 5b

  24. What is the firm’s short-run supply curve? • A curve that indicates the quantity a firm supplies at each price in the short run

  25. p5 • p4 • p3 • p2 • p1 • q2 • q3 • q4 • q5 • Summary of Short-Run Output Decisions • MC • Break-even point • ATC • d5 • AVC • Dollars per unit • d4 • d3 • d2 • d1 • Shutdown point • Quantity per period • Exhibit 5

  26. What is the firm’s short run supply curve? • That portion of its MC curve which lies above its AVC curve

  27. Relationship between Short-Run Profit Maximization and Market Equilibrium • Panel A: Firm • MC = s • ATC • AVC • $5 • Profit • Total dollars • d=MR • 4 • 5 • 10 • 12 • 0 • Quantity per period • Exhibit 8a

  28. What is the industry’s short-run supply curve? • A curve that indicates the quantity all firms in an industry supply at each price in the short run

  29. Aggregating Individual Supply to Form Market Supply • Panel A: Firm A • SA • p' • Price per unit • p • 10 • 20 • 0 • Quantity per period • Exhibit 7a

  30. Aggregating Individual Supply to Form Market Supply • Panel B: Firm B • SB • p' • Price per unit • p • 10 • 20 • 0 • Quantity per period • Exhibit 7b

  31. Aggregating Individual Supply to Form Market Supply • Panel C: Firm C • SC • p' • Price per unit • p • 10 • 20 • 0 • Quantity per period • Exhibit 7c

  32. Aggregating Individual Supply to Form Market Supply • Panel D: Industry, or market supply • SA + SB + SC = S • p' • Price per unit • p • 30 • 60 • 0 • Quantity per period • Exhibit 7d

  33. Relationship between Short-Run Profit Maximization and Market Equilibrium • Panel B: Industry, or market • SMC = S • $5 • Price per unit • D • 12,000 • 0 • Quantity per period • Exhibit 8b

  34. What is economic profit in the long run? • Zero

  35. Long-Run Equilibrium for the Firm • MC • ATC • LRAC • e • d • Dollars per unit • p • q • 0 • Quantity per period • Exhibit 9a

  36. Long-Run Equilibrium for the Industry • S • p • Price per unit • D • Q • 0 • Quantity per period • Exhibit 9b

  37. What is the long-run industry supply curve? • A curve that shows the relationship between price and quantity supplied once firms fully adjust to any change in market demand

  38. What is an increasing-cost industry? • An industry that faces higher per-unit production costs as industry output expands in the long run

  39. What is the shape of the long-run industry supply curve in an increasing cost industry? • Upward sloping

  40. What is production efficiency? • The condition that exists when output is produced with the least-cost combination of inputs, given the state of technology

  41. What is allocative efficiency? • The condition that exists when firms produce the output that is most preferred by consumers

  42. What is the the marginal cost of each good equal to? • The marginal benefit consumers derive from that good

  43. What is consumer surplus? • The difference between the maximum amount that a consumer is willing to pay for a given quantity of a good and what the consumer actually pays

  44. What is producer surplus? • The amount by which total revenue from production exceeds total variable cost

  45. Consumer Surplus and Producer Surplus for a Competitive Market in the Short Run • S • Consumer surplus • e • $10 • Dollars per unit • Producer surplus • D • 6 • 5 • m • 10,000 • 12,000 • 20,000 • 0 • Quantity per period • Exhibit 14

  46. END

  47. Appendix

  48. What is a constant-cost industry? • An industry that can expand or contract without affecting the long-run per-unit cost of production

  49. What is the shape of the long-run industry supply curve? • horizontal

  50. Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry • MC • Panel A: the Firm • d' • p' • ATC • Profit • LRAC • Dollars per unit • d • p • q • q' • 0 • Quantity per period • Exhibit 10a

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