Perfect Competition

1
Perfect Competition

• Chapter 9
• ECO 2023
• Fall 2007

2
Market Structure

• Describes the important feature of a market such
  as
• Number of suppliers
• Products degree of uniformity
• Ease of entry into the market
• Forms of competition among firms
• A firms decisions about how much to produce or
  what price to charge depend on the structure of
  the market

3
Market Models

• Pure Competition
• Pure Monopoly
• Monopolistic Competition
• Oligopoly

4
Perfect Competitive Market

• A market structure with many fully informed
  buyers and sellers of a standardized product and
  no obstacles to entry or exit of firms in the
  long run

5
Characteristics

• Many independent buyers and sellers
• Buyers are small relative to the market
• Standardized product homogeneous
• Price takers individual firms exert no
  significant control over product price.
• Free entry and exit into the industry

6
Perfectly Competitive Market

• Demand under Perfect Competition
• Firms demand is perfectly elastic therefore the
  demand curve is horizontal
• PRICE TAKER
• One and only price exists in the market and it is
  equilibrium price

P
D
Q
7
Average Revenue

• The firms demand schedule is also its average
  revenue schedule
• Price per unit to purchaser is also revenue per
  unit or average revenue

8
Total Revenue

• P X Q
• Since price is constant, increase in sales of one
  unit leads to increase in total revenue to
  price.
• Each unit sold adds exactly its constant price to
  total revenue

9
Marginal Revenue

• Is the change in total revenue that results from
  selling 1 more unit of output
• This is the selling price since it is constant
• Therefore MR AR Price

10
Short Run Profit Maximization

• Each firms tries to maximize economic profit
• Short run it has a fixed plant
• Therefore output is changed through changes in
  variable inputs.
• It adjusts its variable resources to achieve the
  output level that maximizes its profit.
• Two ways to determine level of output at which a
  competitive firm will realize maximum profit or
  minimum loss
• Compare total revenue to total cost
• Compare marginal revenue to marginal cost
• Both apply to all firms
• Firms that ignore this strategy do not survive

11
Example
Bushels per day Total Fixed Costs Total Variable costs Total Cost Total Revenue Economic profit or loss
Q TFC TVC TC TR P X Q where P 131 TR-TC
0 100 0 100 0 -100
1 100 90 190 131 -59
2 100 170 270 262 -8
3 100 240 340 393 53
4 100 300 400 524 124
5 100 370 470 655 185
6 100 450 550 786 236
7 100 540 640 917 277
8 100 650 750 1048 298
9 100 780 880 1179 299
10 100 930 1030 1310 280
12
Graphically
Total Revenue
Maximum Economic Profit
Total Revenue Total Cost
Total Cost
Quantity Demanded
9
13
Marginal Revenue Equals Marginal Cost

• Marginal revenue
• The change in total revenue from selling an
  additional unit
• In perfect competition, marginal revenue is equal
  to the market price
• The firm will increase production as long as each
  additional units adds more to total revenue than
  to cost
• As long as marginal revenue exceeds marginal cost

14
Graphically
Total Product Average Fixed Costs Average Variable Costs Average Total Costs Marginal Costs Marginal Revenue Economic Profit
Q AFC TFC/Q AVC ATC MC MR P  
0 100.00   100.00     (100.00)
        90.00    
1 100.00 90.00 190.00   131.00 (59.00)
        80.00    
2 50.00 85.00 135.00   131.00 (8.00)
        70.00    
3 33.33 80.00 113.33   131.00 53.00
        60.00    
4 25.00 75.00 100.00   131.00 124.00
        70.00    
5 20.00 74.00 94.00   131.00 185.00
        80.00    
6 16.67 75.00 91.67   131.00 236.00
        90.00    
7 14.29 77.14 91.43   131.00 277.00
        110.00    
8 12.50 81.25 93.75   131.00 298.00
        130.00    
9 11.11 86.67 97.78   131.00 299.00
        150.00 131.00  
10 10.00 93.00 103.00     280.00
15
Golden Rule of Profit Maximization

• MR MC

16
Perfectly Competitive Market

• Short run economic profit

Profit
17
Perfectly Competitive Market

• Minimizing Short-Run Losses
• An individual firm in perfect competition has no
  control over the market price
• Price may be so low that a firm loses money no
  matter how much it produces
• Can either produce at a loss
• Temporarily shut down
• Short run
• A period too short to allow existing firms to
  leave the industry

18
Perfectly Competitive Market

• Decision in the short run
• Continue to produce
• A firm will produce if
• TOTAL REVENUE gt VARIABLE COST
• Shut down
• A firm will shut down
• TOTAL REVENUE lt VARIABLE COST

19
Perfectly Competitive Market

• Short run Losses

Loss
20
Perfectly Competitive Market

• Perfect Competition in the Long Run
• If short run has ECONOMIC PROFIT
• Firms enter the industry
• Increase in supply
• Price drops
• Continues until NO ECONOMIC PROFIT in the long
  run
• Price Marginal Cost Average Total Cost

21
Perfectly Competitive Market

• Perfect Competition in the Long Run
• If short run has ECONOMIC Loss
• Firms leavethe industry
• Decrease in supply
• Price rises
• Continues until NO ECONOMIC PROFIT in the long
  run
• Price Marginal Cost Average Total Cost

22
Perfectly Competitive Market

• Productive efficiency
• The condition that exists when market output is
  produced using the least cost combination of
  inputs
• Minimum average cost in the long run
• Allocative efficiency
• The condition that exists when firms produce the
  output most preferred by consumers
• Marginal benefits marginal cost