1. ECON 211 ELEMENTS OF ECONOMICS I
Session 6– Perfect Competition (Part 1)
Lecturer: Dr. (Mrs.) Nkechi S. Owoo, Department of Economics
Contact Information:

2. Session Overview
This session is the first of three that analyze different market structures. Market structure is a way of describing those characteristics of a market that influence the behavior of buyers and sellers when they come together to trade.
To determine market structure, we must ask how many buyers and sellers are in the market, whether the product is standardized, and whether there are barriers to entry.
The answers to these questions help to classify a market into one of four basic types: perfect competition, monopoly, monopolistic competition, or oligopoly.
This session discusses the model of perfect competition.

3. Session Outline
The key topics to be covered in the session are as follows:
What is Perfect Competition?
The Perfectly Competitive Firm
The Competitive Firms Demand Curve
The Competitive Firms Supply Curve

4. Reading List
Hall and Lieberman
Chapter 8, pp:

5. What is perfect competition?
Topic One
What is perfect competition?

6. Firms in Competitive Markets: Introduction
Market Structure
This refers to the x’tics of a market that influence how trading takes place
How do we determine structure of a particular market?
How many buyers and sellers are in the market?
Is each seller offering a standardized product?
Are there any barriers to entry or exit?
Is there perfect knowledge about products?
There are four main classifications of markets
Perfect Competition
Monopoly
Monopolistic competition
Oligopoly
For this semester, we shall discuss the first 2 market structures.

7. Perfect Competition Many buyers and sellers Standardized product
This condition is important so that no individual decision maker can significantly affect the price of the product
Consider the market for maize vs. athletic shoes (Nike, Adidas, New Balance)
Maize is a good example of a perfectly competitive market
Standardized product
buyers do not perceive differences between the products e.g. beans.
The conditions of many buyers and sellers, and the presence of a standardized product imply that no single buyer or seller has any control over price
Would a seller charge more than the going market price? No, because buyers can buy the same product from another seller
Would a buyer demand a lower price? No, because sellers can sell at the given price to other consumers
Therefore, in a perfectly competitive market, buyers and sellers are price takers.

8. Perfect Competition Sellers can easily enter/exit the market
Entry: There are no significant barriers to discourage new entrants
Same terms of entry for all firms
Can you think of some potential barriers to entry?
Large capital requirements, taxation, consumer base, etc
Exit: Any firm can enter and exit the market at any time.
A firm should be able to sell of equipment and exit market if making losses in the long run
Can you think of some potential barriers to exit?
Severance pay to workers, inability to sell of specialized machinery, etc
This condition is important for long-run outcomes in competitive markets, which we will discuss in part 3

9. Perfect Competition Presence of well-informed buyers and sellers
E.g. the Market for maize is a good example
Not all markets satisfy this condition, however
Consumers who purchase ‘China’ fabrics or buy used items e.g. cars, do not have perfect knowledge of the goods being purchased.

10. The Perfectly Competitive Firm
A market is collection of individual buyers and sellers
In PC markets, individual buyers and sellers and overall body (market) affect each other through feedback mechanisms
Therefore, must understand how firm works
..and the competitive market in which it operates

11. The Competitive Firm’s Demand Curve
The demand curve facing the perfectly competitive firm is horizontal– perfectly elastic - at the market price
i.e. No matter how much firm produces, will sell at the same price
Why?
Output is standardized
If firm charges even a little above competitors, will lose all customers
Firm is a tiny producer in overall market
Firm can increase production without lowering price
Price taker
The price of its output is given
Decision
The firm’s main decision is therefore to determine how much output to produce and sell

12. Demand Curves for the Firm and the Industry
The demand curves 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.

13. The Competitive Firm’s Demand Curve vs
The Competitive Firm’s Demand Curve vs. The Competitive Industry Demand Curve
The Competitive Industry and Firm
$400
1. The intersection of the market supply and the market demand curve…
$400
3. The typical firm can sell all it wants at the market price…
Output
Price
Market
Firm
Output
Price S D
Demand Curve Facing the Firm
4. so it faces a horizontal demand curve.
2. determines the equilibrium market price

14. The Revenue of a Competitive Firm
In the perfect competitive market structure, we assume that firms try to maximize profits
Illustration

15. Cost and Revenue Data for a Competitive Firm (Market for Maize)
Output
(bags of maize)
Price per bag
Total Revenue
(P x Q)
Average Revenue
(TR/ Q)
Marginal Revenue
Total Cost
Marginal Cost
Profit
400
550
-550 1
1000
450
-600 2
800
1200
200
-400 3
1250 50
-50 4
1600
1350
100
250 5
2000
1500
150
500 6
2400
1750
650 7
2800
2100
350
700 8
3200
2550 9
3600
3100 10
4000
3750

16. Profit maximization Profits= TR- TC
Firm produces at point that maximizes profits as much as possible
What then, is the profit-maximizing output level?

17. Cost and Revenue Data for a Competitive Firm
Output
Price per ounce
Total Revenue
Marginal Revenue
Total Cost
Marginal Cost
Profit
400
550
-550 1
1000
450
-600 2
800
1200
200
-400 3
1250 50
-50 4
1600
1350
100
250 5
2000
1500
150
500 6
2400
1750
650 7
2800
2100
350
700 8
3200
2550 9
3600
3100 10
4000
3750

18. Profit Maximization
Profit Maximization in Perfect Competition (a) TR-TC
Bags of Maize per Day
Ghc 1 2 3 4 5 6 7 8 9 10 TR TC
2,800
Profit = TR-TC
Maximum Profit
per Day = 700
2,100
550
Slope = 400

19. Profit maximization
Another way to look at profit-maximizing output level
MR- MC approach
When MR > MC, increases in output increase profits
When MC > MR, increases in output reduces profits

20. Cost and Revenue Data for a Competitive Firm
Output
Price per ounce
Total Revenue
Marginal Revenue
Total Cost
Marginal Cost
Profit
400
550
-550 1
1000
450
-600 2
800
1200
200
-400 3
1250 50
-50 4
1600
1350
100
250 5
2000
1500
150
500 6
2400
1750
650 7
2800
2100
350
700 8
3200
2500 9
3600
3100 10
4000
3750

21. Profit Maximization
Profit Maximization in Perfect Competition (b) MR=MC
Bags of Maize per Day
Dollars 1 2 3 4 5 6 7 8 9 10
Profit maximization
MR=MC MC B A
$400
d = MR
Rules for Profit Maximization:
If MR> MC, firm should increase output
If MC> MR, firm should decrease output
When MC= MR, profits are maximized

22. Profit Maximization MC- MR approach
Produce where MR= MC, and MC crosses MR from below!

23. The Firm’s Short-Run Supply Curve
takes the market price as given
decides how much output to produce at that price
Profit-maximizing output level: P=MC (=MR)
As price of output changes, firm will slide along its MC curve in deciding how much to produce
Recall a firm’s cost curves? (AVC, ATV, AFC, MC)
Graphical Illustration

24. Recap: Standard Cost Curves
Units of Output
Ghc 4 3 2 1 30 90
130
160
196 MC
AFC
ATC
AVC

25. The Firm’s Short-Run Supply Curve
Short-Run Supply Under Perfect Competition
(a)
(b)
Bushels per Year
Dollars
Price per Bushel
ATC MC
Firm's Supply Curve
$3.50
d1=MR1
$3.50
2.50
d2=MR2
2.50
2.00
d3=MR3
2.00
AVC
1.00
d4=MR4
1.00
0.50
d5=MR5
0.50
1,000
4,000
7,000
2,000
4,000
7,000
2,000
5,000
5,000

26. The Firm’s Short-Run Supply Curve
As the price of output changes, firm will slide along MC curve in deciding how much to produce
But what if firm is suffering a loss
A loss large enough to justify shutting down?

27. The Firm’s Short-Run Supply Curve
What if P= Ghc2?
(a)
(b)
Output
Ghc
Price
ATC MC
Firm's Supply Curve
3.50
d1=MR1
3.50
2.50
d2=MR2
2.50
2.00
d3=MR3
2.00
AVC
1.00
d4=MR4
1.00
0.50
d5=MR5
0.50
1,000
4,000
7,000
2,000
4,000
7,000
2,000
5,000
5,000

28. The Firm’s Short-Run Supply Curve
What if P= Ghc0.50?
(a)
(b)
Output
Ghc
Price
ATC MC
Firm's Supply Curve
3.50
d1=MR1
3.50
2.50
d2=MR2
2.50
2.00
d3=MR3
2.00
AVC
1.00
d4=MR4
1.00
0.50
d5=MR5
0.50
1,000
4,000
7,000
2,000
4,000
7,000
2,000
5,000
5,000

29. The Firm’s Short-Run Supply Curve
What if P= Ghc1?
(a)
(b)
Output
Ghc
Price
ATC MC
Firm's Supply Curve
3.50
d1=MR1
3.50
2.50
d2=MR2
2.50
2.00
d3=MR3
2.00
AVC
1.00
d4=MR4
1.00
0.50
d5=MR5
0.50
1,000
4,000
7,000
2,000
4,000
7,000
2,000
5,000
5,000

30. The Shutdown Price
Price at which a firm is indifferent between producing and shutting down
If P>AVC – produce
If P<AVC – shut down
Firm’s supply curve
Is its MC curve for all prices above AVC, and a vertical line at zero units for all prices below AVC.

31. The Shutdown Point
The firm will shut down if it cannot cover average variable costs.
A firm should continue to produce as long as price is greater than average variable cost. i.e. P> AVC
Once price falls below that point it makes sense to shut down temporarily and save the variable costs.
Consider the case of Basement on campus

32. The Shutdown Point
The shutdown point is the point at which the firm will gain more by shutting down than it will by staying in business.
As long as total revenue is more than total variable cost, temporarily producing at a loss is the firm’s best strategy since it is taking less of a loss than it would by shutting down.

33. References
Economics: Principles and Applications: Hall R.E. and Lieberman M. (2008), Thomson/ South Western (4th Edition)