CH12 :Perfect Competition Asst. Prof. Dr. Serdar AYAN

Types of Markets Pure Competition or Perfect Competition Monopoly Duopoly Oligopoly Monopolistic Competition

Perfect Competition

Assumptions of Perfect Competition Many independent firms Each seller is small relative to the whole market Homogeneous (identical) product Easy entry and exit Perfect Information

Price Taking The perfectly competitive firm is said to be a price-taker, because it takes the market price as given and has no control over the price. Why?...

If the firm tried to charge a higher price, it would lose all its business. Customers could go elsewhere to buy the same product for less. Since the firm is very small, it can sell as much as it wants at the market price. So there’s no reason to charge a lower price.

The demand curve for the product of the perfectly competitive firm shows how much can be sold at specific prices. Let’s see what it would look like... The firm can sell as little or as much as it wants at the market price. Suppose, for example, the market price is 5TL.

The firm can sell 10 units for 5TL. price 5TL 10 quantity

The firm can sell 20 units for 5TL. price 5TL 20 quantity

The firm can sell 30 units for 5TL. price 5TL 30 quantity

The firm can sell 40 units for 5TL. price 5TL 40 quantity

The firm can sell 50 units for 5TL. price 5TL 50 quantity

So all these points are on the demand curve for the firm’s product. price 5TL quantity

Connecting these points, we have the demand curve for the firm’s product. price 5TL demand quantity

The demand curve for the perfectly competitive firm’s product is a horizontal line at the market price. price market price demand quantity

Total Revenue = Price x Quantity Recall: Total Revenue Total Revenue = Price x Quantity TR = P x Q

Recall: Marginal Revenue (MR) Marginal Revenue is the additional revenue earned from selling one additional unit of output. MR = DTR / DQ

comment For ease of writing, instead of writing the “perfectly competitive” firm we will frequently write the “p.c.” firm.

The MR Curve for the p.c. Firm For the p.c. firm, MR is equal to the market price. So MR is a horizontal line at the level of that price. The demand curve for the p.c. firm is also a horizontal line at the level of the market price. So, for the p.c. firm, the demand curve and the MR curve are the same horizontal line.

The demand curve (D) and the MR curve for the perfectly competitive firm’s product. price market price D = MR quantity

Optimal Output Level Recall: To maximize profit, the firm will produce at the output level where MR = MC. So the firm will produce where the MR and MC curves intersect.

Draw your axes; label them quantity and TL.

Draw your ATC, AVC, and MC curves Draw your ATC, AVC, and MC curves. (Make sure MC intersects ATC and AVC at the minimum.) TL ATC AVC MC Quantity

Draw the D = MR curve horizontal at the market price. TL D = MR ATC AVC MC Quantity

If the market price is P1 , the quantity produced will be Q1. TL D = MR P1 ATC AVC MC Quantity Q1

If the market price is P2 , the quantity produced will be Q2. TL ATC D = MR P2 AVC MC Quantity Q2

If the market price is P3 , the quantity produced will be Q3. TL ATC AVC P3 D = MR MC Quantity Q3

If the market price is P4 , the quantity produced will be Q4. TL ATC AVC P4 D = MR MC Quantity Q4

If the market price is P5 , the quantity produced will be Q5. TL ATC AVC D = MR P5 MC Quantity Q5

Shutdown Point Price P5 was the minimum of the AVC curve (the shutdown point). If the price fell any lower than P5 the firm would produce no output.

The p.c. firm’s short run supply curve The firm’s supply curve shows the quantity the firm will produce at each price. The P, Q values we have shown, therefore, are points on the firm’s supply curve. But those points are all on the firm’s MC curve. So, the firm’s supply curve is the part of the MC curve that is above the minimum of the AVC curve.

The p.c. firm’s short run supply curve TL ATC AVC MC Quantity

The market short run supply curve To determine the total amount that all the firms will produce at each price, we simply add up the amounts that each of the firms will produce at that price.

Graphing Profit

A little trick for graphing a firm’s profit Recall for a rectangle: Area = length . width

We also know TR = P . Q. So, if we can find a rectangle whose length is P and whose width is Q, then its area must be total revenue. P TR Q

To determine Total Cost, first remember ATC = TC / Q So, ATC . Q = TC

To determine Total Cost, first remember ATC = TC / Q So, ATC . Q = TC Now, if we can find a rectangle whose length is ATC and whose width is Q, then its area is TC. Q

Then to determine profit, we just subtract the TC area from the TR area.

Graphing Profit: The six steps

Step 1 a. Draw your axes and label them Q and TL. ( Label the origin 0 Quantity

Step 1b. Draw the firm’s ATC curve Step 1b. Draw the firm’s ATC curve. (If the price is below the minimum of ATC, you will also need to draw the AVC curve.) TL MC ATC P Quantity

Step 1 c. Draw the MC curve and D=MR curve Step 1 c. Draw the MC curve and D=MR curve. (For a positive profit, D must be at least partly above ATC.) MC TL ATC P D = MR Quantity

Step 2: Determine the profit-maximizing output (Q Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC. MC TL ATC P D = MR Quantity Q*

Step 3: Find your TR = PQ rectangle. TL MC ATC P D = MR Quantity Q*

Step 4: Determine ATC at the profit-maximizing output level. MC TL ATC P D = MR ATC Quantity Q*

Step 5: Find your TC = ATC . Q rectangle. MC TL ATC P D = MR Quantity Q*

Step 6: Find profit p = TR - TC. MC TL ATC P p r o f i t D = MR Quantity Q*

You follow the same steps to draw a firm that is making a loss or breaking even (zero profits). Let’s do a firm with a loss.

MC TL ATC AVC D = MR Quantity Step 1: Draw & label the curves & axes. For a loss, put D above the minimum of AVC & below the minimum of ATC. MC TL ATC AVC P D = MR Quantity

Step 2: Determine the profit-maximizing output (Q Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC. MC TL ATC AVC P D = MR Quantity Q*

Step 3: Find your TR = PQ rectangle. MC TL ATC AVC P D = MR Quantity Q*

Step 4: Determine ATC at the profit-maximizing (or loss-minimizing) output level. MC TL ATC ATC AVC P D = MR Quantity Q*

Step 5: Find your TC = ATC . Q rectangle. MC TL ATC ATC AVC P D = MR Quantity Q*

Step 6: Find profit (or loss) p = TR - TC. MC TL ATC AVC l o s s P D = MR Quantity Q*

A firm that is breaking even (zero profits)

Step 1: Draw & label the curves & axes Step 1: Draw & label the curves & axes. To break even, make D tangent to the minimum of ATC. MC TL ATC D = MR P Quantity

Step 2: Determine the profit-maximizing output (Q Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC. MC TL ATC D = MR P Quantity Q*

Step 3: Find your TR = PQ rectangle. MC TL ATC D = MR P Quantity Q*

Step 4: Determine ATC at the profit-maximizing output level. MC TL ATC D = MR ATC = P Quantity Q*

Step 5: Find your TC = ATC . Q rectangle. MC TL ATC D = MR ATC = P Quantity Q*

Step 6: Find profit p = TR - TC. MC TL ATC D = MR ATC = P Quantity Q*