Perfect competition: occurs when none of the individual market participants (ie buyers or sellers) can influence the price of the product. Price determined by market S & D Price taker Won’t charge higher or lower than market price Horizontal (perfectly elastic) at market price.

Market demand Individual firm

Large number of buyers and sellers No collusion between sellers Identical/homogenous goods Completely free entry into and exit from the market Buyers and sellers have perfect knowledge of market conditions. No government intervention FOP perfectly mobile

Price taker - no control over the market price. Only choose output (quantity) at which profits maximised (or losses minimised). Profits maximised where MR = MC – As long as AR (=P) ≥ AVC (shut-down rule). Since MR =P; profit maximized where P=MC

Losses maximised Profits maximised

Profit maximised where MR = MC = P 2 This occurs at Q 2 At Q 2, AR = P 2 = AC (C 2 ) AR = AC, no economic profit earned. Normal profit earned, since all its costs, including self-employed resources, are fully covered. E 2 aka break even point

Can also be found by TR - TC TR = P 2 X Q 2 = 0P 2 E 2 Q 2 TC = C 2 X Q 2 = 0C 2 E 2 Q 2 0C 2 E 2 Q 2 (TC) = 0P 2 E 2 Q 2 (TR)

Economic profits: profit that a business makes that is more than the normal profit. total revenue total costs (or AR > AC). Economic profit occurs when total revenue > total costs (or AR > AC). AKA excess profit, abnormal profit, supernormal profit or pure profit.

Profit is maximised where MR = MC = P 1 This occurs at Q 1 At Q 1, AR = P 1 and AC = C 1 At Q 1, AR (P 1 ) > AC (C 1 ) Economic profit earned – above breakeven point.

Can also be found by TR - TC TR = P 1 X Q 1 = 0P 1 E 1 Q 1 TC = C 1 X Q 1 = 0C 1 MQ 1 0P 1 E 1 Q 1 (TR) > 0C 1 MQ 1 (TC) Difference = Economic Profit = C 1 P 1 E 1 M

Economic loss: occurs when a firm makes less than normal profit. I.e. price (AR) < AC

Profit is maximised where MR = MC = P 3 This occurs at Q 3 At Q 3, AR = P 3 and AC = C 3 At Q 3, AR (P 3 ) < AC (C 3 ) Economic loss = C 3 – P 3

Can also be found by TR - TC TR = P 3 X Q 3 = 0P 3 E 3 Q 3 TC = C 3 X Q 3 = 0C 3 MQ 3 0P 3 E 3 Q 3 (TR) < 0C 1 MQ 3 (TC) Difference = Economic Loss = P 3 C 3 ME 3

If a firm is making an economic loss, should they leave the market? VARIABLE Depends on average revenue (P) relative to average VARIABLE costs (shut down rule!). P < AVC If P < AVC, best to leave the industry.

To summarise… Is a firm making an economic profit, normal profit or economic loss??? STEP 1: (MR = MC) STEP 1: Find the point at which profit is maximized (MR = MC) as this is where all firms will produce. STEP 2: AR & AC STEP 2: At the point where MR=MC, what is the difference between AR & AC? AR>AC = economic profit AR>AC = economic profit AR=AC = normal profit AR=AC = normal profit AR<AC = economic loss AR<AC = economic loss

The rising part of the firm’s MC curve above minimum of AVC = firm’s supply curve.

Industry in equilibrium in the long run only if all firms make normal profits only.

Market forces dictate Private firms & gov. have no power Market mechanism, (think Adam Smith’s invisible hand), determines WHAT, HOW and FOR WHOM… Are perfectly competitive markets fair? Must have purchasing power to participate – only money votes count Leads to very uneven distribution of income and wealth Only goods that people ‘vote’ for are produced.