Perfect Competition
A Perfectly Competitive Market
A
perfectly competitive market is one in which economic forces operate unimpeded.
A Perfectly Competitive Market
A
perfectly competitive market must meet the following requirements:
Both buyers and sellers are price takers. The number of firms is large. There are no barriers to entry. The firms products are identical. There is complete information. Firms are profit maximizers.
The Definition of Supply and Perfect Competition
If
all the necessary conditions for perfect competition exist, we can talk formally about the supply of a produced good.
The Definition of Supply and Perfect Competition
Supply
is a schedule of quantities of goods that will be offered to the market at various prices.
The Definition of Supply and Perfect Competition
When
a firm operates in a perfectly competitive market, its supply curve is that portion of its short-run marginal cost curve above average variable cost.
Demand Curves for the Firm and the Industry
The
demand curves facing the firm is different from the industry demand curve. A perfectly competitive firms demand schedule is perfectly elastic even though the demand curve for the market is downward sloping.
The Perfect Competitors Demand Curve
Firm 9 8 7 6 5 4 3 2 1 D,MR 6 5 4 3 2 1 D Industry S
10
15
20 25 Output
30
3 4 5 6 Output (in millions)
Why is the individual firms demand curve flat instead of sloping down to the right?
The individual firms output is between 0 & 30 units. The industrys output in the millions. It is
impossible for the individual firm to increase output enough to change the price even one cent..
Demand Curves for the Firm and the Industry
Individual
firms will increase their output in response to an increase in demand even though that will cause the price to fall thus making all firms collectively worse off.
Market Demand Versus Individual Firm Demand Curve
Price $10
8 6 4 Market demand 1,000 3,000 Quantity Market Market supply Firm
Price $10
8 6 4
Individual firm demand
2 0
2 0
10 20 30 Quantity
Profit-Maximizing Level of Output
The
goal of the firm is to maximize profits. Profit is the difference between total revenue and total cost.
Profit-Maximizing Level of Output
happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC). A firm maximizes profit when MC = MR.
What
Profit-Maximizing Level of Output
Marginal
revenue (MR) the change in total revenue associated with a change in quantity.
Marginal
cost (MC) the change in total cost associated with a change in quantity.
Marginal Revenue
A
perfect competitor accepts the market price as given. As a result, marginal revenue equals price (MR = P).
Marginal Cost
Initially,
marginal cost falls and then begins to rise.
Profit Maximization: MC = MR
To
maximize profits, a firm should produce where marginal cost equals marginal revenue.
How to Maximize Profit
If
marginal revenue does not equal marginal cost, a firm can increase profit by changing output. The supplier will continue to produce as long as marginal cost is less than marginal revenue.
How to Maximize Profit
The
supplier will cut back on production if marginal cost is greater than marginal revenue.
Thus,
the profit-maximizing condition of a competitive firm is MC = MR = P.
The Marginal Cost Curve Is the Supply Curve
The
marginal cost curve is the firm's supply curve above the point where price exceeds average variable cost.
The Marginal Cost Curve Is the Supply Curve
The
MC curve tells the competitive firm how much it should produce at a given price.
The
firm can do no better than produce the quantity at which marginal cost equals marginal revenue which in turn equals price.
The Marginal Cost Curve Is the Firms Supply Curve
$70 60
Cost, Price
Marginal cost
C
50
40
A
B
30 20
10 0 1 2 3 4 5 6 7 8 9 10 Quantity
Profit Maximization Using Total Revenue and Total Cost
Profit
is maximized where the vertical distance between total revenue and total cost is greatest. At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal.
Profit Determination Using Total Cost and Revenue Curves
TC Loss $385 350 315 Maximum profit =$81 280 245 210 $130 175 140 105 Profit =$45 70 Loss 35 0 Total cost, revenue TR
Profit
1 2 3 4 5 6 7 8 9
Quantity
Total Profit at the ProfitMaximizing Level of Output
The
P = MR = MC condition tells us how much output a competitive firm should produce to maximize profit. It does not tell us how much profit the firm makes.
Determining Profit and Loss From a Table of Costs
Profit
can be calculated from a table of costs and revenues. Profit is determined by total revenue minus total cost.
Determining Profit and Loss From a Graph
Find
output where MC = MR.
The intersection of MC = MR (P) determines the quantity the firm will produce if it wishes to maximize profits.
Determining Profit and Loss From a Graph
Find
profit per unit where MC = MR.
Drop a line down from where MC equals MR, and then to the ATC curve. This is the profit per unit. Extend a line back to the vertical axis to identify total profit.
Determining Profit and Loss From a Graph
The
firm makes a profit when the ATC curve is below the MR curve.
The
firm incurs a loss when the ATC curve is above the MR curve.
Determining Profit and Loss From a Graph
Zero
profit or loss where MC=MR.
Firms can earn zero profit or even a loss where MC = MR. Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.
Determining Profits Graphically
MC MC MC Price Price Price 65 65 65 60 60 60 55 55 55 ATC 50 50 50 ATC 45 45 45 40 40 D A P = MR 40 P = MR Loss 35 35 35 P = MR Profit 30 30 30 B ATC AVC 25 25 C 25 AVC AVC E 20 20 20 15 15 15 10 10 10 5 5 5 0 0 0 1 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12 Quantity Quantity Quantity (b) Zero profit case (a) Profit case (c) Loss case
The Shutdown Point
The
firm will shut down if it cannot cover average variable costs.
A firm should continue to produce as long as price is greater than average variable cost. If price falls below that point it makes sense to shut down temporarily and save the variable costs.
The Shutdown Decision
MC Price 60 50 40 30 20 $17.80 A 10 0 2 4 6 8 Quantity Loss P = MR AVC ATC
Long-Run Competitive Equilibrium
Profits
and losses are inconsistent with long-run equilibrium.
Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made. The existence of losses will cause firms to leave the industry.
Long-Run Competitive Equilibrium
Only The
at zero profit will entry and exit stop.
zero profit condition defines the longrun equilibrium of a competitive industry.
Long-Run Competitive Equilibrium
MC
Price 60 50 40
SRATC P = MR LRATC
30
20 10 0 2 4 6 8
Quantity