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MAIN TOPIC: MICRO ECONOMICS

TOPIC 6: PERFECT MARKETS

6.1 Perfect competition

6.2 Individual business and industry

6.3 Market structure

6.4 Output, profits, losses and supply

 Individual business
 The industry

6.5 Competition policies

Examine the dynamics of perfect markets with the aid of cost and income
curves.

NOTE:
1. Review cost and revenue tables and curves done in Grade 11.
2. Distinguish between the short and long run.

Concepts:
Concept Description
The Competition Appeals Court Should any dispute over the
recommendations arise, it will be
referred to the Competition Appeals
Court.
The Competition Commission An institution that investigates restrictive
business practices, abuse of dominant
positions and mergers to acquire shares
in the South African economy.
The Competition Tribunal An institution with the main function to
approve major mergers, to appeal
against misconduct cases, and to issue
orders on submissions submitted by the
Competition Commission.
Economic loss Total cost is more than total income.
When average income exceeds average
cost, the business makes an economic
loss.
Economic profit Profit that is additionally made to normal
profit. When average income is higher
than average cost, the business makes
economic profit.
Explicit cost Actual expenditure of an enterprise, e.g.
wages and interest.

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Implicit cost Value of inputs owned by the

entrepreneur and used in the production
process (rent, interest and salaries
given)
Short term The production period during which only
the variable factors can change while at
least one factor remains fixed in this
period.
Long term The production period during which all
factors can change. The period is long
enough for all factors to change.
Market An institution or mechanism that brings
together buyers and sellers of goods and
services
Market structure How a market is organised.
Monopoly Exclusive management of a good or
service in a certain market
Monopolistic competition A structure where businesses have
many competitors but each sells a
slightly different product (e.g. CDs and
books)
Normal profit The minimum earnings required to
prevent an entrepreneur from leaving the
industry. When average revenue equals
average cost, the business makes
normal profit.
Oligopoly A market structure controlled by a small
group of companies
Price take Has no influence on the price. Accept
the price determined by the market.
Shutdown point The business will close when MC = AVC
Perfect competition A market structure with a large number
of buyers and sellers

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What is a market?
 Can be defined as buyers and sellers who influence the price of a good or service.
OR
 It is an institution or mechanism that brings together the buyers and sellers of a
good or a service.
OR
 It exists as a result of the interaction between buyers (demand) and sellers
(supply). It is also called the market mechanism.

What is market conduct?

 Market conduct involves the things done by firms in their capacity as suppliers and
buyers and relates to their objectives, competition methods to achieve their
objectives and inter firm conduct.

What are the objectives of the business?

 To make profits
 To increase turnover
 To grow the business

The market structure

The major organisational features of a market, (e.g. number of sellers/buyers the

degree of product differentiation/the availability of information) are called the structure
of the market.

There are FOUR market structures / types of markets

1 Perfect Competition
2 Imperfect competition:
o Monopolistic competition
o Oligopolies
o Monopolies

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DIFFERENT TYPES OF COSTS

MC = Marginal Cost
It is the amount by which the total cost increase
when one extra unit of a product is produced.

∆Total Cost (TC) ÷ ∆ Output (Q) = MC

MR = Marginal Revenue
Marginal revenue refers to the extra amount of
income earned when an additional (extra) unit of
a product is sold.

∆TR ÷∆ Q = MR

AC = Average Cost
Fixed Cost + Variable Cost = Total Cost
Total Cost ÷ Total output = AC.
Also called unit cost.

AR = Average Revenue
Average revenue refers to the amount the
enterprise earns for every unit sold.

TR ÷ Q = AR

Because TR = P x Q,
it follows that AR = PQ ÷ Q
therefore, AR = Price

AVC = Average Variable Cost

Variable cost divided by number of units
produced.
Variable costs ÷ total output = AVC.

P = Price
A value that will purchase a definite quantity,
weight, or other measure of a good or service.

Q = Quantity
The extent, size, or sum of countable or
measurable discrete events, objects, or
phenomenon, expressed as a numerical value.

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ECONOMIC COST

Economic cost of production = Opportunity cost = Explicit Cost + Implicit cost

Explicit cost

Explicit cost is the actual expenditure of a business on the purchase or hire of the
inputs required for the production process.

Explicit costs include:

 Wages of labourers / Interest on borrowed capital / Rent on leasing land and
buildings
 Expenditure on raw material / Water / Electricity / Property taxes /Motor car
expenses

Implicit costs

Implicit costs = is the value of inputs that are owned by the entrepreneur and used in
the production process.

Implicit costs include:

 Forfeited rent that could have been earned if the owner used his own building.
 Forfeited interest that could have been earned if the owner had invested his/her
money.
 Forfeited salary that could have been earned if the owner had worked elsewhere
and earned a salary.

6.1 PERFECT COMPETITION (PERFECT MARKETS)

Describe the term: Perfect competition

 It is a market structure with a large number of participants who are all price takers,
there are no entry or exit barriers in the long run, all information is available to both
the buyers and sellers and a homogeneous product is sold.
OR
 A market in which the conditions for perfect competition are satisfied.
OR
 Perfect competition occurs when none of the individual market participants can
influence the price of the product

Examples of markets in perfect competition

 Stock exchange
 Foreign currency market
 Central grain exchange market
 Market for agricultural produce

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Markets are impersonal

 Businesses strive towards maximum profit and only take its own cost structure into
account, when determining the production levels.
 All are price takers.

CHARACTERISTICS OF PERFECT COMPETITION

Many buyers and sellers:

 The number of buyers and sellers in the market is so large that individual market
participants are insignificant in relation to the market as a whole.
 The number of buyers and sellers in the market is so large that the individual buyer
or seller cannot influence the market price (price takers).

Homogenous product:
 All the products sold in the specific market are homogenous, that is, they are
exactly the same regarding quality, appearance, etc.
 It makes no difference to a buyer where or from whom he/she buys the product.

Freedom of entry / exit:

 There is complete freedom of entry and exit, that is to say the market is fully
accessible.
 Buyers and sellers are completely free to enter or to leave the market.
 Entry should not be subject to any restrictions in the form of legal, financial,
technological or other barriers that curtail the freedom of movement of buyers and
sellers.

Mobility of factors of production:

 All factors of production are completely mobile, in other words labour, capital and
all other factors of production can move freely from one market to another.

Perfect information:
 Both buyers and sellers have full knowledge of all the prevailing market conditions.
 For example if one business ventured to raise its price above the market price,
buyers would immediately become aware of it and would switch their purchases to
businesses who still charge the lower price.

No collusion:
 Collusion between sellers does not occur.
 In a perfectly competitive market, each buyer and seller acts independently from
one another.
 Collusive practices are illegal in South Africa, according to the Competition Act
1998.

Unregulated market:
 There is no government intervention that could affect buyers or sellers.
 Decisions are left to individual sellers or producers and buyers.

No preferential treatment (no discrimination):

 Nobody is advantaged above the others.

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Efficient transport and communication:

 Makes access to and from markets possible.

6.2 THE INDIVIDUAL BUSINESS AND THE INDUSTRY

 Individual businesses form a small part of the market, therefore, they do not
influence market price. Individual business is a price taker.
 Market price is determined by the interaction of demand and supply.
 DD (demand curve) slopes downwards from top left to bottom right and SS (supply
curve) slopes upwards from bottom left to top right.
 The point where demand and supply intersect, is called the equilibrium.
 Individual business can offer any quantity on the market at the market price.
 Business will not charge a higher price, because buyers will buy elsewhere and
they will not charge a lower price, because they can sell all their goods at the
current market price.

DEMAND CURVE FOR INDIVIDUAL BUSINESS

Sketch A Sketch B

Sketch B
 Demand curve for individual business is a horizontal line at market price.
 For each unit sold, business receives the same price – the market price,
Therefore P1 = AR = MR equals individual demand curve.

 The average revenue the business receives is therefore equal to the market
price and the horizontal demand curve represents the average revenue curve
(AR).
 The revenue from any additional unit the business sells, that is the marginal
revenue, is equal to market price P1, and the horizontal demand curve
therefore also represents the marginal revenue curve (MR).

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REVENUE TABLE

Perfect market

Fixed Cost

Fixed Cost
Total Cost

Total Cost
Product /

Revenue

Revenue

Revenue
Marginal

Marginal
Average

Average

Average

Average
Variable
variable
Output

Profit
Price
Total

Total
Cost

Cost
cost
0 0 40 0 40 -40
1 35 40 28 68 40 28 68 35 28 35 35 -33
2 35 40 48 88 20 24 44 35 20 70 35 -18
3 35 40 64 104 13.33 21.33 34.66 35 16 105 35 1
4 35 40 78 118 10 19.5 29.5 35 14 140 35 22
5 35 40 90 130 8 18 26 35 12 175 35 45
6 35 40 107 147 6.67 17.83 24.5 35 17 210 35 63
7 35 40 129 169 5.71 18.42 24.13 35 22 245 35 76
8 35 40 159 199 5 19.88 24.88 35 30 280 35 81
9 35 40 199 239 4.44 22.11 26.55 35 40 315 35 76
10 35 40 253 293 4 25.3 29.3 35 54 350 35 57
11 35 40 440 480 3.64 40 43.63 35 187 385 35 -95

Profit maximisation

Total Cost (TC) and Total Revenue (TR)

 Between 0 and 3 units the firm makes a loss (TC is greater than TR).
 At 3 units the firms economic profit is zero.
 Between 3 units and 8 units the firm makes economic profit.
 At 8 units the firm makes zero profit.
 Beyond 8 units the firm is making a loss (TC is greater than TR)

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Marginal cost (MC) and Marginal Revenue (MR)

When
MR ˃ MC (marginal revenue greater than marginal cost) = output should increase
MR = MC (marginal revenue equals marginal cost) = profit is maximized
MR ˂ MC (marginal revenue lower than marginal cost) = output should be reduced

Supply of the business

 Under perfect competition profits are maximized where SMC = MR and it is used to
derive business’s supply curve
 The different market prices are taken to determine how much a business would
produce at each price.
 The production determines the supply curve.
 Average variable cost (AVC) consists of the per unit value of e.g. labour cost,
material cost, fuel and electricity cost, etc.

Sketch A Sketch B

(Enjoy Economics, p. 94)

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Sketch A
 The market price rises due to an increase in demand.
 The increase in the market demand is shown as a rightward shift of the market
demand curve.

Sketch B
 The horizontal demand curve for the business’ product shifts upward: Demand
= AR = MR.
 The horizontal demand curve intersects the SMC at point e1, e2 and e3 (to the
right of the previous point)
 Each point shows the profit maximisation point where SMC = MR.
 Points e1, e2 and e3 plot business’s supply at different market prices – supply
begins at e1.
 The firm’s supply starts at e1, where the AR = AVC.
 The amount supplied by the business increase as price increase.

Below point e1
 To the left of point e1: business cannot even cover its variable cost.
 The business should close its doors.
 Also known as shutdown point.

Important:
 To determine the market supply, the supply curves of all the businesses are
added horizontally.
 In the short term the supply curve is also called the market supply curve.

Equilibrium positions:
 In a perfect market the individual business faces a perfectly horizontal demand
curve.
 The market price is determined by the industry (demand and supply curves).
 This means that individual businesses are price takers i.e. they are not able to
influence prices.
 An individual business can increase or decrease output in order to maximize
profit.
 Profit is maximized where SMC = MR.
 This is the point at which profit is maximized; (loss minimized) which is known
as the equilibrium point.

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THE INDUSTRY

The industry’s short term supply curve

 The short term supply curve is also called the market supply curve.
 The market supply curve of the industry is derived by horizontally adding up the
quantity supplied (at a particular price) of individual businesses.
 The market is used as a synonym for the industry.

(Enjoy Economics, p. 98)

 At R400 business A supplies 50 products and business B supplies 100 products.

 The market supply is 150 units of the product at a price of R400.

 The location and shape of the supply curve are determined by technology and the
price of factors of production.

The industry’s short term equilibrium

 The industry is in equilibrium at a price that clears the market.
 That is at a price where the quantity demanded is equal to the quantity supplied.
 Short term equilibrium of the industry will not apply in the long term.
 Businesses that make economic profit in the short term will have to expand their
businesses in the long term.
 As a result of economic profit, more businesses will be attracted to the industry.
 Businesses that make losses and who are unable to adjust their business will have
to close in the long term.

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6.3 MARKET STRUCTURES

Perfect Imperfect Competition

Competition
Characteristics/ Perfect Monopoly Oligopoly Monopolistic
Criteria Competition Competition
Number of So many that no ONE Seller and Small number Large number
Firms / single business many buyers of businesses / of businesses /
Businesses can influence the sellers. sellers.
market price

Nature of Products sold on Products / Products are Products are

product the market are services are homogenous or differentiated.
homogeneous, unique with no differentiated.
e.g. maize close
substitutes
Entrance Entry is Entry is Entry into the Free entry and
completely free completely market varies exit into the
restricted or from free to market.
blocked restricted.
Market Both buyers and Buyers and Incomplete Information for
Information sellers have full sellers have full information buyers and
knowledge of all knowledge of between buyers sellers is
the prevailing all the and sellers. incomplete.
market prevailing
conditions market
conditions
(Complete)
Collusion Impossible. Irrelevant, only Collusion is There are many
Sellers act one firm possible. sellers /
independently producers and
from each other. this makes
collusion
impossible.
Control over Price taker - no Is regarded as Have control Businesses
price control cover a price maker over prices. have little
price Have some They are price control over
The market control over makers. prices of
determines the price products.
price for the Prices not
individual firm determined by
market
forces of supply
and demand
but by
the business
itself

Considerable
control over the
price of the
product, but
limited by

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market demand
and the goal of
profit
maximization.
Output The demand Demand curve Demand curve Demand curve
demand curve curve for the slopes is downward is downward
for firms’ / perfect downward and sloping. sloping.
businesses competitor is it equals the
product. horizontal - market demand
(Perfectly elastic) curve

Economic The perfect The monopolist Can make Make normal

profit competitor can also realise economic profit profit
realise economic economic in the long term.
profits in the profits in the
short term short term
Abnormal profits The monopolist
will attract will charge a
new entrants into higher price
the market than the perfect
for both competitor
structures The monopolist
Both perfect will not produce
market and at the lowest
monopoly can point of the
only realise LAC, like the
normal profits in perfect
the long term competitor, the
The price for the output will be
product for both less than the
market structures perfect
equals the competitor
average cost Both perfect
The perfect and monopoly
competitor does can only realise
produce the ideal normal profits
production in the long term
quantity and has The
no surplus monopolist's
capacity production will
be less than the
ideal production
quantity where
LAC is the
minimum and
has surplus
capacity

Allocative Efficient Inefficient Inefficient Inefficient

Efficiency
Productive Efficient Inefficient from Inefficient from Inefficient from
Efficiency a society point a society point a society point
of view of view of view

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Decision- Decision has no Independent Influenced by Influenced by

making influence on other other
others competitors competitors

Examples International Eskom Petrol and oil, Fast food

commodity DSTV Cellular phones, outlets,
markets e.g. Stainless Steel Motorcars Clothing stores,
gold, oil, etc. (Columbus Household
Financial steel) furniture, etc.
Markets (JSE).

Allocative efficiency: (Also called Pareto efficiency)

 It is where goods and services are allocated in the most efficient manner.
 Allocative efficiency is obtained when a distribution strategy exists where one
party's situation cannot be improved without making another party worse off.

Productive efficiency (Technical efficiency):

 The production of goods and services in the least costly way and without wasting
scarce resources.

6.4 Output (Production), Profit, Loss and Supply

6.4.1 Individual business

 Under perfect competition the demand curve for the individual business is a
horizontal line at the market price.
 To obtain maximum profits for the business, only the given market price and its
own cost structure are taken into account when determining its production output.

(Enjoy Economics, p. 93)

At point e
 Horizontal demand curve represents MR and AR.
 Maximum profit at point e. This is the point where SMC = MR.
 It is known as the equilibrium point.
 Point e = profit maximization = equilibrium

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At point g
 Profits are not maximized.
 Businesses render revenue that is greater than the marginal cost.
 MR lies above SMC.
 Business Expand its production up to a point where SMC = MR on the
ascending part of the SMC.

At point h
 The business makes a loss on each product when producing here and it
reduces it profits.
 At point h, SMC ˃ MR (SMC more than MR)
 The output unit produced at point q3 costs more to produce than the price that
will be received for it.
 It does not benefit the business to produce here, because it makes a loss on
that particular unit.

At point j
 Maximum losses are made here.
 The business will not produce here.
 It is on the descending part of the SMC.

Profit for the Business

Normal Profit

 The business makes normal profit which is the minimum earnings required to
prevent the entrepreneur from closing the business and using his factors of
production elsewhere.
 Equilibrium is at point e1. The business will produce at this point where SMC = MR.
 At point e1, Q1 goods are produced at a price of P1.
 Point e1 is the Profit Maximisation point of the business.

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At point e:
 Average cost is equal to price.
 The SAC curve is tangent to the demand curve which means that P/AR = SAC (TR
= TC).
 The firm makes only normal profits.

Economic Profit
 This is a profit which is made in addition to normal profits.
 This is the difference between Total Revenue and Total Cost.

 Business maximizes profit at point e2.

 Equilibrium is at point e2. At this point SMC = MR.
 The business produces at market price P2 and the quantity produced is Q2.
 The averages cost for Q2 units is point R on the SAC curve.
 Price (or AR) is greater than SAC. (TR > TC)

E.g.

 Total Revenue = OP2 x OQ2

 Total Cost = OS x OQ2

 Total revenue is more than Total cost.

 The business makes a profit.
 The economic profit area is represented by P2e2RS

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Loss for the business

 The minimum point of the SAC curve is higher than the market price P 3.
 The business (firm) is in equilibrium is at point e3. The firm will produce
where SMC = MR.
 At point e3, Q3 goods are produced at a price of P3.
 At equilibrium (point e3) Price/AR is less than Average Cost.
 The AC lies above the demand curve which means that P/AR < AC (TR < TC)
 The business makes an economic loss.

E.g.

 Total cost is represented by OM x OQ3 = OMLQ3

 Total Revenue is represented by OP3 x OQ3 = OP3e3Q3

 Total Revenue is less than Total Cost

 The business makes a loss.
 The loss is indicated by P3MLe3

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SHUTDOWN POINT

 The rising part of the businesses’ MC curve above the minimum of its average
variable cost curve represents the supply curve of the business.
 The supply curve starts at point A (shutdown-point) and slopes upward from there
due to the marginal cost that increases as output increases.
 At a market price of P1 the business is only able to pay its variable costs.
 If the market price drops below P1 the business will be forced to close down and
this point (A) is known as shutdown-point.

6.4.2 The industry’s long-term equilibrium

Compare the individual firm and industry under conditions of perfect

competition.

(Enjoy Economics, p. 100)

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 The industry is in equilibrium at the price that clears the market.

 It is the price at which the quantity demanded is exactly equal to the quantity
supplied.

1. In the long run, two things can change:

(a) New businesses can enter or leave the market.

(b) Businesses can adjust their production capacity.

All factors of production become variable and existing firms earning
economic profit in the short run may decide to expand their plant size to
realize economies of scale.

2. Economic profit
 Suppose the business's short-term plant is represented by SAC1.
 If the market price is P1 the business is making an economic profit of
P1E1FP2 with the short-term plant-size represented by SAC1.
 At a price of P1 the business will maximise profit in the short-term at point E 1
where the profit maximisation (MR=MC) applies, and the quantity q 1 will be
produced.

3. Bigger plant, lower unit cost

 If the producer does a cost estimate, he/she will realize that he/she will be
able to produce at a lower unit cost in the long-run.
 This is illustrated by the downward sloping portion of the LAC curve.
 The prospect of increased profit would therefore encourage the producer to
build a bigger plant.
 The business would however not be interested in producing output levels
greater than those presented by the minimum point E2 of the LAC because
such output levels are only possible at higher cost levels – internal scale
disadvantages cause the LAC to rise to the right of point E2.

4. New entrants, increased supply

 The economic profit that businesses make is likely to attract new
businesses to the industry.
 The quantity offered on the market increases as a result of expansion by
existing businesses and the entry of new businesses. The market supply
curve will shift to the right from S to S1 and the price will drop until it
eventually reaches P.
 At the price P, which is at the same level as the minimum point of the LAC
curve, total revenue (0P X 0q2) is equal to total cost (0q2 X q2E2).
 At 0q2 the business is making normal profit, because it is exactly covering
its total cost.
 Over time all the businesses in the industry will make normal profit and will
be in long run equilibrium.

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5. Initial losses
 Individual firms can be in equilibrium in the short run where it makes an
economic profit or an economic loss.
 These positions, however, are not sustainable in the long run under
conditions of perfect competition.
 If the market price is below the minimum point of the long-term average cost
curve, the adjustment process simply works the other way around.
 Eventually the LAC curve will also form a tangent with the demand curve
and the businesses that have remained in the industry will be making
normal profit.

6. Price in the long term

 The above analysis leads to the conclusion that under perfect competition
the price of a product in the long term will settle at a level that corresponds
to the lowest point of the LAC curve.
 A point such as E2 represents the equilibrium point of the business in the
long run.
 The business is making normal profit and there will be no incentive to leave
or enter the industry.
 When a market price has been established under perfect competition at a
level where each business is in equilibrium at the minimum point of its LAC
curve and only making normal profit, the industry will also be in long-term
equilibrium.

7. Equilibrium
 Once long-term equilibrium has been achieved, and provided that there are
no changes in the technology or the factors of production, there will be no
further entry or exit of businesses.

COMPETITION POLICY

Definition

Competition policy wants to promote competition and prevent the abuse and
exploitation of economic power and instead exploit the advantages of healthy
competition to benefit the society as a whole.

 Markets can only operate efficiently if there is healthy competition.

 The first step in promoting competition is to open up a country's economy to
imports.
 South Africa was one of the founder members of the World Trade Organisation
(WTO) in 1994.
 The WTO promotes global free trade through the reduction of import tariffs and the
abolition of import control.

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The aims of the competition policy in South Africa

 Prevent the abuse of economic power, e.g. by a monopolist.

 Regulate the growth of market power by means of takeovers and mergers.
 Prevent restrictive practices, especially by oligopolist, such as fixing of selling
prices, collusion in respect of tenders or price discrimination.
 Contribute to the developmental objectives of the state.
 To improve efficiency of markets through legislation.
 Improve equity in markets e.g. Employment Equity Act.
 Protect the consumer against unfair prices and inferior products e.g. Competition
Act.
 Prevent price fixing.
 Promote competition.

THE ANC’s POLICY ON MONOPOLY FORMULATION

 In 1994 the African National Congress, which propagated a strict anti-monopoly

policy, came to power in South Africa.

This meant a further boost for competition policy in the country:

 A great deal of emphasis was placed on the fact that there should be no
restrictions on entry (to any industry), because this would be to the detriment of
previously disadvantaged groups.
 These groups should obtain access to resources and economic power in order
to promote economic transformation in the country.
 A further objective was to curb the economic power of the big conglomerates in
the South African economy in order to arrive at a more equitable distribution of
income and wealth.
 The fact that South Africa was able to regain access to the world economy also
served to make South African businesses more competitive.
 Another factor was that new trade agreements with other countries made it
mandatory for South African competition law to comply with certain
requirements.

PROVISIONS OF THE COMPETITION ACT 89 OF 1998

 The result of the above developments was the adoption of a new law, the
Competition Act 89 of 1998.
 This act makes provision for a:
o Competition Commission
o Competition Tribunal
o Competition Appeals Court

Compiled by A. Green – Metro North Education District Adapted by Economics Subject Advisers 2018
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1. Competition Commission

 The Competition Commission tries to give all South Africans equal

opportunities to participate fairly in economic activities in order to make the
economy more efficient.
 One of the provisions of the act is that the Competition Commission must be
advised of any mergers and takeovers.
 Mergers cannot take place without the consent of the Commission.
 When the Commission evaluates mergers, any matters relating to competition
and efficiency, and the public interest, must be taken into account.

2. Competition Tribunal

 The Commission's recommendations are submitted to the Competition

Tribunal.
 The Commission Tribunal can accept or reject the recommendation made by
the competition commission.

3. Competition Appeal Court

 If there are any disputes over the recommendations, they are referred to the
Competition Appeal Court.

Compiled by A. Green – Metro North Education District Adapted by Economics Subject Advisers 2018