1. Chapter 10: Perfect Competition
Prepared by:
Kevin Richter, Douglas College
Charlene Richter,
British Columbia Institute of Technology
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Chapter Objectives
1. List the six conditions for a perfectly competitive market.
2a. Explain why producing an output at which marginal cost equals price maximizes total profit for a perfect competitor.
2b. Demonstrate why the marginal cost curve is the supply curve for a perfectly competitive firm.
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Chapter Objectives
3a. Determine the output and profit of a perfect competitor graphically and numerically.
3b. Explain the role of profits as market signals.
4a. Construct a market supply curve by adding together the marginal cost curves of individual firms.
4b. Explain why perfectly competitive firms make zero economic profit in the long run.
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Chapter Objectives
5. Explain the adjustment process from short-run equilibrium to long-run equilibrium.
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Perfect Competition
The concept of competition is used in two ways in economics.
Competition as a process is a rivalry among firms.
Competition as a market structure.
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6. Perfectly Competitive Market
A perfectly competitive market is one in which economic forces operate unimpeded.
It has highly restrictive assumptions which provide us with a reference point we can use in comparing different markets.
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7. Perfectly Competitive Market
In a perfectly competitive market:
The number of firms is large.
The firms' products are identical.
There is free entry and exit, that is, there are no barriers to entry.
There is complete information.
Firms are profit maximizers.
Both buyers and sellers are price takers.
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8. Necessary Conditions for Perfect Competition
There is free entry and free exit.
Firms are free to enter a market in response to market signals such as price and profit.
Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market.
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9. Necessary Conditions for Perfect Competition
Both buyers and sellers are price takers.
A price taker is a firm or individual who takes the market price as given.
Neither supplier nor buyer possesses market power.
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10. Demand Curves for the Firm and the Industry
The demand curve facing the firm is different from the industry demand curve.
A perfectly competitive firm’s demand schedule is perfectly elastic even though the demand curve for the market is downward sloping.
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11. Market Demand Curve Versus Individual Firm Demand Curve
Market supply
1,000
3,000
Price
$10 8 6 4 2
Quantity 10 20 30
Price
$10 8 6 4 2
Quantity
Market
demand A B C
Individual firm demand
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12. Profit-Maximizing Level of Output
Marginal revenue (MR) – the change in total revenue associated with a one-unit change in quantity.
Marginal cost (MC) – the change in total cost associated with a one-unit change in quantity.
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13. Marginal Cost, Marginal Revenue, and PriceMC 1 2 3 4 5 6 7 8 9 10
$28.00
20.00
16.00
14.00
12.00
17.00
22.00
30.00
40.00
54.00
68.00
Price = MR
Quantity Produced
Marginal Cost
$35.00
35.00
Costs 1 2 3 4 5 6 7 8 9 10
Quantity 60 50 40 30 20 C A
P = D = MR A B
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14. Marginal Cost Curve Is the Firm’s Supply Curve
Cost, Price
$70 60 50 40 30 20 10 1
Quantity 2 3 4 5 6 7 8 9 C A B
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15. Firms Maximize Total Profit
Firms seek to maximize total profit, not profit per unit.
Firms do not care about profit per unit.
As long as an increase in output yields even a small amount of additional profit, a profit-maximizing firm will increase output.
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16. Profit Maximization Using Total Revenue and Total CostTC TR
Total cost, revenue
$385
350
315
280
245
210
175
140
105 70 35
Quantity 1 2 3 4 5 6 7 8 9
Loss
Maximum profit =$81
Profit
$130
Profit =$45
Loss
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17. Costs Relevant to a Firm
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18. Costs Relevant to a Firm
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19. Determine Profit 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.
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20. Determine Profits Graphically
Quantity
Price 65 60 55 50 45 40 35 30 25 20 15 10 5 1 2 3 4 6 7 8 9 12 D MC A
P = MR B
ATC
AVC E
Profit C
Loss
(a) Economic Profit
(b) Zero economic profit
(c) Loss
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Shutdown Point
The shutdown point is the point at which the firm will be better off if it shuts down than if it stays in business.
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Shutdown Decision MC 2 4 6 8
Quantity
Price 60 50 40 30 20 10
ATC
Loss
P = MR
AVC A
$17.80
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Profits as Signals
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24. Long-Run Competitive EquilibriumMC 60 50 40 30 20 10
Price 2 4 6 8
Quantity
SRAC
LRAC
P = MR
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25. Long-Run Competitive Equilibrium
In order to stay in business the entrepreneur must receive his opportunity cost or normal profits (the amount the owners of business would have received in the next-best alternative).
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26. Long-Run Competitive Equilibrium
Normal profits are included as a cost. Economic profits are profits above normal profits.
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27. Long-Run Competitive Equilibrium
Firms with super-efficient workers or machines will find that the price of these specialized inputs will rise.
Rent is the income received by those specialized factors of production.
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28. Long-Run Competitive Equilibrium
The zero profit condition is enormously powerful.
As long as there is free entry and exit, price will be pushed down to the average total cost of production.
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Increase in Demand
An increase in demand leads to higher prices and higher profits.
Existing firms increase output.
New firms enter the market, increasing output still more.
Price falls until all profit is competed away.
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Increase in Demand
If input prices remain constant, the market is a constant-cost industry, and the new equilibrium will be at the original price but with a higher output.
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31. Market Response to an Increase in Demand
Quantity
Price
Firm
Price
Quantity MC AC D1
S0SR D0
S1SR B B $9
840 $9 C
Profit 12 7
700
SLR 7 A
1,200 10 A
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32. Long-Run Market Supply
Two other possibilities exist:
Increasing-cost industry – factor prices rise as new firms enter the market and existing firms expand capacity.
Decreasing-cost industry – factor prices fall as industry output expands.
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33. Canadian Retail Industry
During the 1990s the Canadian retail industry illustrated how a competitive market adjusts to changing market conditions.
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34. Canadian Retail Industry
Many retailers were lost or absorbed by competitors: Eaton’s, Bretton’s, Pascal’s, Robinson’s, K-Mart and many others.
Initially, these firms saw their losses as the temporary result of reduced demand in a slowing economy.
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35. Canadian Retail Industry
As prices fell, P=MR fell below their ATC.
But since price remained above the AVC, many firms closed their less profitable locations and continued to operate.
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36. Canadian Retail Industry
When demand did not recover, firms ran out of options.
Many firms realized as they moved into the long run that they have to exit the Canadian retail industry.
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Shutdown Decision
Price
Quantity MC
ATC
Loss
AVC
P = MR
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Perfect Competition
End of Chapter 10
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