Perfect Competition

1
Perfect Competition
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FOUR MARKET MODELS
Characteristics of Pure Competition

• Many small firms
• Identical products (perfect substitutes)
• Firms are Price Takers
• Easy for firms to enter and exit the industry
• No control over price.
• No need to advertise

Pure Monopoly
Pure Competition
Monopolistic Competition
Oligopoly
Market Structure Continuum
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Review

1. Why is a perfectly competitive firm a price
   taker?
2. How do firms determine what output to produce?
3. Draw and label a perfectly competitive firm
   producing 10 units making a profit of 30
4. Draw and label a perfectly competitive firm
   producing 10 units making a loss of 30
5. On your graph, identify the firms supply curve
6. On your graph, identify the shut down point
7. What happens in the industry if there is a
   profit?
8. What happens in the industry if there is a loss?
9. Draw a perfectly competitive firm in long run
   equilibrium

4
The Competitive Firm is a Price Taker Price is
set by the Industry
Is the firm making a profit or a loss? Why?
P
P
S
MC
ATC
Loss
DMR
10
10
D
Q
Q
400
8
Firm (price taker)
Industry
5
What is TR?
What is TC?
300
250
Profit/Loss per unit?
5
How much is the profit or loss?
50
Where is the Shutdown Price?
22
35 30 25 20 0
MC
MRP
ATC
Cost and Revenue
AVC
22
1 2 3 4 5 6 7 8 9 10
6
Perfect Competition in the Long-Run
You are a wheat farmer. You learn that there is a
more profit in making corn. What do you do in the
long run?
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In the Long-run

• Firms will enter if there is profit
• Firms will leave if there is loss
• So, ALL firms break even, they make NO economic
  profit
• (No Economic ProfitNormal Profit)
• In long run equilibrium a perfectly competitive
  firm is EXTREMELY efficient.

7
8
Side-by-side graph for perfectly completive
industry and firm in the LONG RUN
Is the firm making a profit or a loss? Why?
P
P
S
MC
ATC
MRD
15
15
D
Q
Q
8
5000
Firm (price taker)
Industry
8
9
Firm in Long-Run Equilibrium
Price MC Minimum ATC Firm making a normal
profit
P
MC
ATC
15
MRD
There is no incentive to enter or leave the
industry
TC TR
8
Q
9
9
10
Going from Long-Run to Short-Run
10
11

1. Is this the short or the long run? Why?
2. What will firms do in the long run?
3. What happens to P and Q in the industry?
4. What happens to P and Q in the firm?

P
P
S
MC
ATC
MRD
15
15
D
Q
Q
8
5000
6000
Industry
Firm
11
12
Firms enter to earn profit so supply increases in
the industry Price decreases and quantity
increases
P
P
S
MC
S1
ATC
MRD
15
15
10
D
Q
Q
8
5000
6000
Industry
Firm
12
13
Price falls for the firm because they are price
takers. Price decreases and quantity decreases
P
P
S
MC
S1
ATC
MRD
15
15
10
MR1D1
10
D
Q
Q
8
5000
5
6000
Industry
Firm
13
14
New Long Run Equilibrium at 10 Price Zero
Economic Profit
P
P
MC
S1
ATC
10
MR1D1
10
D
Q
Q
5000
5
6000
Industry
Firm
14
15

1. Is this the short or the long run? Why?
2. What will firms do in the long run?
3. What happens to P and Q in the industry?
4. What happens to P and Q in the firm?

P
P
S
MC
ATC
MRD
15
15
D
Q
Q
8
5000
4000
Industry
Firm
15
16
Firms leave to avoid losses so supply decreases
in the industry Price increases and quantity
decreases
S1
P
P
S
MC
ATC
20
MRD
15
15
D
Q
Q
8
5000
4000
Industry
Firm
16
17
Price increase for the firm because they are
price takers. Price increases and quantity
increases
S1
P
P
S
MC
ATC
20
20
MR1D1
MRD
15
15
D
Q
9
Q
8
5000
4000
Industry
Firm
17
18
New Long Run Equilibrium at 20 Price Zero
Economic Profit
S1
P
P
MC
ATC
20
20
MR1D1
D
Q
9
Q
4000
Industry
Firm
18
19
Going from Long-Run to Long-Run
19
20
Currently in Long-Run Equilibrium If demand
increases, what happens in the short-run and how
does it return to the long run?
P
P
S
MC
ATC
MR1D1
MRD
15
15
D
Q
Q
8
5000
Industry
Firm
20
21
Demand Increases The price increases and
quantity increases Profit is made in the short-run
P
P
S
MC
ATC
20
20
MR1D1
MRD
15
15
D1
D
Q
9
Q
8
5000
Industry
Firm
21
22
Firms enter to earn profit so supply increases in
the industry Price Returns to 15
S1
P
P
S
MC
ATC
20
20
MR1D1
MRD
15
15
D1
D
Q
9
Q
8
5000
7000
Industry
Firm
22
23
Back to Long-Run Equilibrium The only thing that
changed from long-run to long-run is quantity in
the industry
S1
P
P
MC
ATC
MRD
15
15
D1
D
Q
Q
8
7000
Industry
Firm
23
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Efficiency
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PURE COMPETITION AND EFFICIENCY
In general, efficiency is the optimal use of
societies scarce resources

• Perfect Competition forces producers to use
  limited resources to their fullest.
• Inefficient firms have higher costs and are the
  first to leave the industry.
• Perfectly competitive industries are extremely
  efficient

There are two kinds of efficiency
1. Productive Efficiency
2. Allocative Efficiency
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Efficiency Revisited
Which points are productively efficient? Which
are allocatively efficient?
14 12 10 8 6 4 2 0
Productive Efficient combinations are A through
D (they are produced at the lowest cost)
A
B
G
Bikes
Allocative Efficient combinations depend on the
wants of society
C
E
F
D
0 2 4 6 8 10
Computers
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Productive Efficiency
The production of a good in a least costly way.
(Minimum amount of resources are being used)
Graphically it is where
Price Minimum ATC
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Short-Run
MC
ATC
DMR
Profit
Price
P
Notice that the product is NOT being made at the
lowest possible cost (ATC not at lowest point).
Q
Quantity
28
29
Short-Run
MC
ATC
Price
Loss
P
DMR
Notice that the product is NOT being made at the
lowest possible cost (ATC not at lowest point).
Q
Quantity
29
30
Long-Run Equilibrium
MC
ATC
DMR
Price
P
Notice that the product is being made at the
lowest possible cost (Minimum ATC)
Q
Quantity
30
31
Allocative Efficiency
Producers are allocating resources to make the
products most wanted by society.
Graphically it is where
Price MC
Why? Price represents the benefit people get from
a product.
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Long-Run Equilibrium
MC
MR
P
Price
Optimal amount being produced
The marginal benefit to society (as measured by
the price) equals the marginal cost.
Q
Quantity
32
33
What if the firm makes 15 units?
MC
MR
5
Price
The marginal benefit to society is greater the
marginal cost. Not enough produced. Society
wants more
3
15
20
Underallocation of resources
Quantity
33
34
What if the firm makes 22 units?
MC
7
MR
5
Price
The marginal benefit to society is less than the
marginal cost. Too much Produced. Society wants
less
22
Overallocation of resources
20
Quantity
34
35
Long-Run Equilibrium
MC
ATC
DMR
Price
P
P Minimum ATC MC EXTREMELY EFFICIENT!!!!
Q
Quantity
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