Perfect Competition Chapter 9 ECO 2023 Fall 2007

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

Market Models Pure Competition Pure Monopoly Monopolistic Competition Oligopoly

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

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

Perfectly Competitive Market Demand under Perfect Competition Firm’s 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

Average Revenue The firm’s demand schedule is also its average revenue schedule Price per unit to purchaser is also revenue per unit or average revenue

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

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

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

Economic profit or loss 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 $100 $0 -$100 1 90 190 131 -59 2 170 270 262 -8 3 240 340 393 +$53 4 300 400 524 +124 5 370 470 655 +185 6 450 550 786 +236 7 540 640 917 +277 8 650 750 1048 +298 9 780 880 1179 +299 10 930 1030 1310 +280

Graphically Total Cost Total Revenue & Total Cost Quantity Demanded Maximum Economic Profit Total Revenue & Total Cost Total Cost Quantity Demanded 9

Marginal Revenue Equals Marginal Cost 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

Average Variable Costs 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   $ 100.00 $ 100.00 $ (100.00) $ 90.00 1 $ 90.00 $ 190.00 $ 131.00 $ (59.00) $ 80.00 2 $ 50.00 $ 85.00 $ 135.00 $ (8.00) $ 70.00 3 $ 33.33 $ 80.00 $ 113.33 $ 53.00 $ 60.00 4 $ 25.00 $ 75.00 $ 124.00 5 $ 20.00 $ 74.00 $ 94.00 $ 185.00 6 $ 16.67 $ 91.67 $ 236.00 7 $ 14.29 $ 77.14 $ 91.43 $ 277.00 $ 110.00 8 $ 12.50 $ 81.25 $ 93.75 $ 298.00 $ 130.00 9 $ 11.11 $ 86.67 $ 97.78 $ 299.00 $ 150.00 10 $ 10.00 $ 93.00 $ 103.00 $ 280.00

Golden Rule of Profit Maximization MR = MC

Perfectly Competitive Market Short run economic profit Demand = Marginal Revenue = Price = Average Revenue $5 $4 12 Price MC ATC Profit Quantity Profit

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

Perfectly Competitive Market Decision in the short run Continue to produce A firm will produce if TOTAL REVENUE > VARIABLE COST Shut down A firm will shut down TOTAL REVENUE < VARIABLE COST

Perfectly Competitive Market Short run Losses Demand = Marginal Revenue = Price = Average Revenue $5 $4 12 Price MC ATC Loss Quantity Loss

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

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

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