Perfect Competition

1
Perfect Competition

• Completely Unrealistic Yet Entirely Relevant

2
Market Structures

• In Economics, we identify four basic market
  structures.
• A market structure reflects three basic
  characteristics
• Number of firms in the market
• Product differentiation
• Ease of entry into the market

3
Four Market Structures

• Perfect Competition many firms selling the same
  product
• Monopolistic Competition many firms selling
  differentiated products
• Oligopoly few firms selling differentiated (yet
  very similar) products
• Monopoly a great board game, ALWAYS buy the
  railroads if you can!
• HA HA Seriously, that is the LAST monopoly is a
  board game joke for the yearwell, maybe.
• In reality, a monopoly is always one firm selling
  a unique product.

4
Perfect Competition

• Very many firms
• Generally, the firms are very small, could be
  just one person who works for him or herself.
• Wide selling radius
• In perfect competition, the small firm must sell
  its products in a wide market, usually nationally
  or internationally
• Standardized products
• The product produced by one firm cannot differ in
  any way from that produced by another
• No need for advertisement or any other forms of
  non-price competition
• Price-Takers
• A firm in perfect competition cannot set the
  price of their product
• The market will determine the price, the firm can
  only choose the quantity sold
• Attempts at changing the price by a firm will
  result in less than the profit maximized position
• Free Entry and Exit
• Firms may come and go with no barriers (legal,
  technological, financial, etc.)

5
Examples of Perfect Competition

• Truthfully, there are not many.
• Farming used to be a good example, but today most
  farms are owned by large corporations and entry
  into the market is very financially difficult for
  small farmers
• Stock Market
• Each share of a stock is exactly the same as the
  next share
• Why would the following NOT be perfectly
  competitive?
• Airline Industry
• Clothing Industry
• Television Broadcasting
• Private Education

6
The Industry and the Firm

• An industry is a place where many firms sell
  their products to many buyers.
• Within the industry, the supply curve reflects
  all of the supply curves of all of the firms
  added together.
• Within the industry, the demand curve reflects
  all of the demand curves of all of the buyers
  added together.
• The equilibrium point in the industry tells us
  two things.
• First, the price that all firms in the perfectly
  competitive industry MUST accept.
• Second, the total quantity of the product that
  will be produced by all of the firms in the
  industry.
• Since, each firm within a perfectly competitive
  industry is so small, they can choose to produce
  as much or as little as they want
• If they were large enough to have a significant
  market share, the industry would no longer be
  perfectly competitive.

7
The Graph
Horizontal Demand Curve
Note the EQ price
8
The Graph What to Know

• The Difference Between the Industry and Firm
• For the firm, Marginal Revenue Demand Average
  Revenue Priceor

MR. DARP
Mr. Darp, seen here, is always horizontal
at the market price
9
Lets Get the Numbers Down
CENSORED
10
Profit Maximization Short Run

• We know that profit maximization occurs where MR
  MC.
• In the case of a perfectly competitive firm, MR
  P, so P MC at the profit maximized level
• At this point, we can determine the quantity that
  will be produced by the firm.
• What happens to the quantity produced when the
  demand in the industry increases?
• What happens when the variable costs of
  production increase at each level of production?

11
The Short-Run Profit

• In order to determine the profit of the firm, we
  have to analyze the revenue and costs.
• We know, at the point of profit maximization,
  what the average revenue (AR) is. What is it?
• Its the PRICE! (AR P)
• Now, all we need to know is the average cost of
  each unit we product (ATC).
• Profit P ATC since this tells us how much
  profit will be made at the profit maximized
  level.
• Exercise
• In the last table, identify the AVERAGE TOTAL
  COST for each level of production.
• Graph the MR, AR, MC, and AC.

12
Identifying Short-Run Profit
The Profit

• Lets identify
• Total Revenue
• Total Cost
• Total Profit

13
Graphical Analysis

• The graph tells us
• The total revenue (big box)
• The total cost (the bottom portion)
• The total profit (the box between the AR (D) line
  and the total cost box)
• Complete 1 from Activity 34

14
Sometimes, Mr. Darp aint so nice

• In the instance where MR. DARP is above ATC, the
  firm will be making economic profit (i.e. profit
  even with opportunity costs being accounted for).
  
• What might happen, however, if the industry
  demand were to fall? Lets see

15
Minimized Short-Run Losses

• When the ATC is above AR at the profit maximized
  point, the firm is actually going to lose money.
• In this instance, their loss is minimized. If
  they choose to produce at another level, the loss
  becomes worse.
• In the short-run, the firm will have a decision
  to make
• Continue to operate in the short-run and lose
  money or
• Shut down and lose money
• Rule In the short run, a firm will continue to
  operate if
• A. Profits are being made
• B. Losses are smaller than fixed costs (revenue
  is above the average variable cost curve)/

16
Graphically Speaking

• In the short run, a firm will remain open when
• MRDARP is above the ATC curve or
• MRDARP is below the ATC curve but above the
  AVC curve
• In the short run, a firm will shut-down when
• MRDARP is below the AVC curve
• In your notes, draw an example of each.
• Note that in the short-run, the firms supply
  curve is its MC curve above the AVC curve.

17
So, what happens in the long run?

• Firms, in the long run, will be able to escape
  from fixed costs if they wish to.
• Under the condition where a firm is taking any
  kind of loss in the short run, the firm will exit
  the industry in the long-run
• Under any condition where a firm is making a
  profit in the short-run, the firm will continue
  to operate...

18
Exit and Entry

• In the long run, firms can exit with no trouble.
  Other firms can also enter the industry with no
  trouble.
• What will cause a firm to leave the industry in
  the long-run?
• What will cause a firm to enter the industry in
  the long-run?
• The next step

19
Industry Supply

• As firms enter and exit the industry, the
  industry supply curve is affected.
• If there is above zero-economic profit being made
  by firms in and industry, more firms will enter
  the industry
• If more firms enter the industry, the supply of
  the industry will shift to the right
• What will happen to price? What will this do to
  the profit maximizing firm that is making profit
  in the short-run?

20
Competition in the Long-Run
More firms
MRDARP falls
21
Long-Run Profit

• As more firms enter, those firms making an
  economic profit will see their profit shrink
• This process will continue until all firms in the
  long-run are making ZERO ECONOMIC PROFITS.
• The long-run condition for firms in perfect
  competition is ZERO ECONOMIC PROFITS
• Under this condition, MRMCATC.
• The same situation occurs for firms that are
  taking losses

22
Losses and Zero Economic Profit

• If firms are taking losses in the short-run, they
  will exit in the long-run.
• As firms exit, the industry supply curve shifts
  to the left
• What will happen to the industry price?
• What will happen for firms taking losses in the
  short-run that stay open?
• Again, the price will rise until all firms
  operating in long-run equilibrium are making ZERO
  ECONOMIC PROFIT.

23
What does this mean?

• Fact In perfect competition, firms will operate
  with ZERO-ECONOMIC PROFIT.
• Fact In perfect competition, firms will operate
  at maximized efficiency. Firms that survive in
  the long-run will produce at the lowest point on
  their ATC curve.
• Fact In perfect competition, consumers will pay
  the lowest price possible for any given good or
  service.
• Not Fact Perfect competition is real and alive
  and well