Perfect Competition I.Assumptions II.Market vs. Firm demand III.Short Run Equilibrium –1.The Total Approach: Numerical Ex. –2.The Marginal Approach. a.Profits b.Losses c.Shut-down d.Short-run Supply Curve e.Calc. Approach d∏/dQ = 0

Contents IV.Long-run equilibrium. –1.Super-normal profits  Entry –2.Losses  Exit. V.Industry SS Curve: Horizontal Summation of firm SS curves.

Assumptions behind Perfect Competition 1.Product Homogeneity All firms sell an identical product. There is no way the buyer can differentiate among different firms' products. 2.Large number of buyers and sellers. No individual firm or buyer, no matter how large their sales or purchases, can influence market quantity. 3.Free entry and exit of firms. No barriers either cost or legal barriers to entry  Promotes competition. 4.Perfect knowledge Sellers and buyers have complete knowledge of the market. 5.Factor Mobility: Factors of production are free to move from one firm to another.

Market and Firm Demand: Although market demand may slope downwards, firm demand is always perfectly elastic. Given the large number of sellers and perfect knowledge if a firm tries to raise its price above the market price, it will lose all its business.

Market and Firm Demand Graphs

SR EQUILIBRIUM – TOTAL APPROACH

Short-run equilibrium

1.The Total Approach: Maximize ∏ = TR - TC Profits (∏) Total Revenue (TR) = Price (P) * Quantity (Q) Numerical example: See handout Note:(1) ∏ = ∏ max when the gap between TR and TC is largest. (2)∏ = ∏ max when MR = MC. (TR from each additional unit sold) (TR per unit sold) Note:P = AR = MRunder Perfect Competition.

Short-run equilibrium The Marginal Approach – Graphs (a)Firm makes a Profit (b)Firm makes a Loss

Short-run equilibrium Marginal Approach –Firm makes a profit –Firm makes a loss –Firm breaks even

Short-run equilibrium Shut-down Decision of the Firm Idea max ∏ or min losses. Px < AVC min  Shut down because you minimize your losses by only paying fiscal costsSince you can't cover any variable costs producing output only increases losses Esc: If you cannot even cover the paychecks of employees it is better to shut-down and pay only the rent on land and machinery rather than also have to pay employees out of your own pocket.

SR SHUT DOWN DECISION & SUPPLY CURVE OF THE FITM

Short-run equilibrium The Marginal Approach – Calculus ∏ (Q) = TR (Q) –TC(Q) =0

Short-run equilibrium The Marginal Approach – Calculus Example

Long-run equilibrium Super-normal profits exist.  Firms enter the industry to reap those profits  Industry SS shifts S.E.  Market equilibrium price falls.  Profits are completed away (by higher input costs)  Long-run equilibrium is achieved. Price falls till P = LMC = AC min

Long-run equilibrium Firms are making losses  Some firms exit the industry to avoid losses greater than Total Fixed Costs.  Industry SS shifts N.W.  Market equilibrium price rises till P = LMC = AC min

Shifts in Cost Curves SR: (Better tech. or more of a fiscal input). Change in FC shifts ATC but not AVC Change in VC shifts AVC and ATC. LR:All costs are variable.