1. Chapter 24
Perfect Competition

2. Characteristics of a Perfectly Competitive Market Structure
Perfect Competition
A market structure in which the decisions of individual buyers and sellers have no effect on market price

3. Characteristics of a Perfectly Competitive Market Structure
Perfectly Competitive Firm
A firm that is such a small part of the total industry that it cannot affect the price of the product or service that it sells

4. Characteristics of a Perfectly Competitive Market Structure
Price Taker
A competitive firm that must take the price of its product as given because the firm cannot influence its price

5. Characteristics of a Perfectly Competitive Market Structure
Scenario
A wheat farmer delivers his winter wheat crop to the grain elevator and is offered a price of $3.00/bushel.
How many bushels will he sell if he wants $3.01/bushel for his wheat?
Can he sell any additional bushels by offering to sell for $2.99/bushel?

6. Characteristics of a Perfectly Competitive Market Structure
Characteristics of perfect competition
Large number of buyers and sellers
Homogenous products
When you buy a head of lettuce do you ask what farm it came from?
No barriers to entry or exit
Buyers and sellers have equal access to information

7. International Example: A Common Pricing Denominator in Europe
Perfect competition is more likely in an environment where buyers and sellers have equal access to information.
In Europe accurate decisions on prices of substitutes was limited by the need to compare prices of goods produced in different countries in different currencies.
This should be less of a problem with the establishment of the Euro.

8. Variability in the Domestic Prices of Selected Products in Nine European Nations
Figure 23-1

9. The Demand Curve of the Perfect Competitor
Question
If the perfectly competitive firm is a price taker, who or what sets the price?

10. The Demand Curve for a Minidisk Producer
Neither an individual
buyer or seller can
influence the price S D 5 E
The interaction of market
supply and demand yields
an equilibrium price of $5
and quantity of 25,000 units
Price per Minidisk
10,000
20,000
30,000
40,000
50,000
Minidisks per Day

11. The Demand Curve of the Perfect Competitor
The perfectly competitive firm:
Is a price taker (i.e., must sell for $5)
Will sell all units for $5
Will sell zero units if it wants a higher price
Cannot sell more units at a lower price

12. The Demand Curve for a Minidisk Producer
Industry
Individual firm S D
Price per Minidisk 5 E d 5
10,000
20,000
30,000
40,000
50,000 1 2 3 4 5
Minidisks per Day
Minidisks per Day
Figure 23-2, Panels (a) and (b)

13. How Much Should the Perfect Competitor Produce?
The firm will produce the level of output that will maximize profits given the market price.
Total Revenues
The price per unit times the total quantity sold
Economic profit = total revenue (TR) - total cost (TC)

14. How Much Should the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TR = P x Q
Average revenue (AR)  TR Q PQ 
 P
P determined by the market in perfect competition
Q determined by the producer to maximize profit

15. How Much Should the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TC  explicit + opportunity cost

16. Profit Maximization
Figure 23-3, Panel (a)

17. Profit Maximization Figure 23-3, Panel (b) Total Output/
Sales/ Total Market Total Total
day Costs Price Revenue Profit
0 $10 $5 $0 $10
10 8 5 1 1
Figure 23-3, Panel (b)

18. How Much Should the Perfect Competitor Produce?
Profit-maximizing rate of production
The rate of production that maximizes total profits, or the difference between total revenues and total costs
Also, the rate of production at which marginal revenue equals marginal cost

19. Profit Maximization Figure 23-3, Panel (c) Total Output/
Sales/ Market Marginal Marginal
day Price Cost Revenue
0 $5
1 5
2 5
3 5
4 5
5 5
6 5
7 5
8 5
9 5
10 5
11 5
$5 $5
3 5
2 5
1 5
4 5
5 5
6 5
7 5
8 5
Figure 23-3, Panel (c)

20. Marginal revenue (MR) 
Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production
Marginal revenue (MR) 
∆TR
∆output
Marginal cost (MC) 
∆TC
∆output

21. Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production
Between zero output and MC = MR output, MR > MC and TR is increasing more than TC and profits are increasing
MR > MC

22. Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production
Beyond MC = MR output, MC > MR and TC is increasing more than TR and profits are decreasing.
MR > MC
MC > MR

23. Profit Maximization Total Output/
Sales/ Total Market Total Total Marginal Marginal
day Costs Price Revenue Profit Cost Revenue
0 $10 $5 $0 $10
10 8 5 1 1
$5 $5
3 5
2 5
1 5
4 5
5 5
6 5
7 5
8 5
MR > MC
MR = MC
MR < MC

24. Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production
Profit maximization—a review
Economic profits = TR  TC
Profit-maximizing output occurs at the unit that MC = MR
For a perfectly competitive firm, this is at the intersection of the firms demand schedule and its marginal cost curve

25. Short-Run Profits
To find out what our competitive individual minidisk producer is making in terms of profits in the short run, we have to add the average total cost curve to Panel (c) of Figure 23-3.

26. Price and Cost per Unit ($)
Short-Run Profits 14 13 12 11 10
• Recall: Profits are maximized at 7.5 units where MC = MR.
• How do we measure profits? 9
Price and Cost per Unit ($) 8 7 6 5 4 3 2 1 3 5 7 9 11 1 4 6 8 10 2 12
Minidisks per Day

27. Price and Cost per Unit ($)
Short-Run Profits 14
• Profit is maximized where MR = MC
• ATC = TC/output
• TC = ATC  output
• TR = P  output
• Profit = (P - ATC)  output 13 12 11 MC 10 9
Price and Cost per Unit ($) 8 7
Profits
ATC 6 d 5
P = MR = AR 4 3 2 1 3 5 7 9 11 1 4 6 8 10 2 12
Figure 23-4
Minidisks per Day

28. Price and Cost per Unit ($)
Short-Run Profits 14
• At P = $5, ATC = 4.33
• Output = 5 units
• TR = $5  7.5 = 37.5
• TC = $4.33  7.5 = 32.5
• Profit = = $5 or ($ )  7.5 = $5 13 12 11 MC 10 9
Price and Cost per Unit ($) 8 7
Profits
ATC 6 d 5
P = MR = AR 4 3 2 1 3 5 7 9 11 1 4 6 8 10 2 12
Minidisks per Day

29. Minimization of Short-Run Profits14
• Losses are minimized where MR = MC
• Loss = ($ )  5.5 or $7.43 13 12 11 MC 10 9
Price and Cost per Unit ($) 8 7
ATC 6
Losses d1 5 4 d2 3
P = MR = AR 2 1 3 5 7 9 11 1 4 6 8 10 2 12
Figure 23-5
Minidisks per Day

30. Short-Run Profits
Short-run average profits or average losses are determined by comparing average total costs with price (average revenue) at the profit-maximizing rate of output.
In the short run, the perfectly competitive firm can make economic profits or economic losses.

31. The Short-Run Shutdown Price
What do you think?
Would you continue to produce if you were incurring a loss?
In the short run?
In the long run?

32. Short-Run Shutdown and Break-Even Price
Short-run break-even point
Short-run
shutdown point
Figure 23-6

33. The Short-Run Shutdown Price
What do you think?
Would you continue to produce if you were incurring a loss?
In the short run?
In the long run?

34. The Short-Run Shutdown Price
As long as the price per unit sold exceeds the average variable cost per unit produced, the firm will be covering at least part of the opportunity cost of the investment in the business— that is, part of its fixed costs.

35. The Short-Run Shutdown Price
Short-Run Break-Even Price
The price at which a firm’s total revenues equal its costs
At the break-even price, the firm is just making a normal rate of return on its capital investment
Short-Run Shutdown Price
The price that just covers average variable costs
It occurs just below the intersection of the marginal cost curve and the average variable cost curve

36. The Meaning of Zero Economic Profits
Why produce if you are not making a profit?
Hint:
Distinguish between economic profits and accounting profits
When economic profits are zero, accounting profits are positive

37. The Perfect Competitor’s Short-Run Supply Curve
Question
What does the supply curve for the individual firm look like?
Answer
In Figure 23-7, the firm’s supply curve is the marginal cost curve above the short-run shutdown point.
Thus, the definition of the individual firm’s short-run supply curve in a competitive industry is its marginal costs curve equal to and above the point of intersection with the average variable cost curve.

38. The Individual Firm’s Short-Run Supply Curve
• Given the price, the quantity is determined where MC = MR
• Short-run supply = MC above minimum AVC
Figure 23-7

39. The Perfect Competitor’s Short-Run Supply Curve
The Industry Supply Curve
The locus of points showing the minimum prices at which given quantities will be forthcoming

40. Deriving the Industry Supply Curve
Figure 23-8, Panels (a), (b), and (c)

41. The Perfect Competitor’s Short-Run Supply Curve
Factors that influence the industry supply curve (determinants of supply)
Firm’s productivity
Factor costs
Taxes and subsidies
Number of firms

42. Competitive Price Determination
Question
How is the market, or “going,” price established in a competitive market?
Answer
This price is established by the interaction of all the suppliers (firms) and all the demanders.

43. Competitive Price Determination
The competitive price is determined by the intersection of the market demand curve and the market supply curve
The market supply curve is equal to the horizontal summation of the portions of the individual marginal cost curves above their respective minimum average variable costs

44. Competitive Price Determination
Pe is the price
the firm must take
Pe and Qe determined
by the interaction of
the industry S and
market D
Figure 23-9, Panel (a)

45. Competitive Price Determination
-Given Pe firm produces
qe where MC = MR
-If AC = AC1, break-even
-If AC = AC2, losses
-If AC = AC3, economic
profit
Figure 23-9, Panel (b)

46. The Long-Run Industry Situation: Exit and Entry
Profits and losses act as signals for resources to enter an industry or to leave an industry.

47. The Long-Run Industry Situation: Exit and Entry
Signals
Compact ways of conveying to economic decision makers information needed to make decisions
A true signal not only conveys information but also provides the incentive to react appropriately

48. The Long-Run Industry Situation: Exit and Entry
The profit signal—entry (assumptions)
A perfectly competitive market (wheat) characterized by a normal rate of return (i.e., break-even)
A European crop failure increases the demand for U.S. wheat

49. The Long-Run Industry Situation: Exit and Entry
The profit signal—entry (assumptions)
The increase in demand creates shortages in the U.S. market, the price of wheat increases and economic profits exist
The profits signal for new resources to enter the market
The market returns to a normal rate of return

50. The Adjustment Graphically
Initial market conditions MC S D
ATC
Price of Wheat ($) Pe Qe
d = MR qe
Break-even
Quantity of Wheat (industry)
Quantity of Wheat (firm)

51. The Adjustment Graphically
European crop failure increases U.S. Demand MC D2 S1
ATC Q1 P2 d2 q2
Higher price creates economic profit
Price of Wheat ($) P1 d1 D1 Q1 q1
Quantity of Wheat (industry)
Quantity of Wheat (firm)

52. The Adjustment Graphically
Economic profit attracts new firms
Price fall to break-even MC S1 S2
ATC
Price of Wheat ($) P1 d1 D2 D1 Q1 q1
Quantity of Wheat (industry)
Quantity of Wheat (firm)

53. The Adjustment Graphically
Reaction to losses MC S D
ATC qe
ATC
Price of Wheat ($) Pe Qe
d = MR
Quantity of Wheat (industry)
Quantity of Wheat (firm)

54. The Adjustment Graphically
Losses signal for resources to leave the market Supply falls and price increases to break-even MC S2 S1
ATC P2
d = MR
Price of Wheat ($) P1
Break-even D Q1 q1
Quantity of Wheat (industry)
Quantity of Wheat (firm)

55. The Long-Run Industry Situation: Exit and Entry
Summary
Economic profits
Signal resources to enter the market and the price falls to the break-even price
Economic losses
Signal resources to exit the market and the price increases to the break-even level

56. The Long-Run Industry Situation: Exit and Entry
Summary
At break-even
Resources will not enter or exit because the market is yielding a normal rate of return
In the long run, the perfectly competitive firms will make zero economic profits (normal rate of return)

57. The Long-Run Industry Situation: Exit and Entry
Long-Run Industry Supply Curve
A market supply curve showing the relationship between price and quantities forthcoming after firms have been allowed time to enter or exit from an industry

58. The Long-Run Industry Situation: Exit and Entry
Constant-Cost Industry
An industry whose total output can be increased without an increase in long-run per-unit costs

59. Constant-Cost Industry
Figure 23-10, Panel (a)

60. The Long-Run Industry Situation: Exit and Entry
Increasing-Cost Industry
An industry in which an increase in industry output is accompanied by an increase in long-run per unit costs

61. Increasing-Cost Industry
Figure 23-10, Panel (b)

62. The Long-Run Industry Situation: Exit and Entry
Decreasing-Cost Industry
An industry in which an increase in industry output leads to a reduction in long-run per unit costs

63. Decreasing-Cost Industry
Figure 23-10, Panel (c)

64. Long-Run Equilibrium
Firms will adjust plant size until it has no further incentive to change.

65. Long-Run Firm Competitive Equilibrium
Figure 23-11

66. Long-Run Equilibrium
In the long run, a competitive firm produces where price, marginal revenue, marginal cost, short-run minimum average cost, and long-run minimum average cost are equal.

67. Competitive Pricing: Marginal Cost Pricing
A system of pricing in which the price charged is equal to the opportunity cost to society of producing one more unit of the good or service in question

68. Competitive Pricing: Marginal Cost Pricing
Market Failure
A situation in which an unrestrained market operation leads to either too few or too many resources going to a specific economic activity

69. Policy Example: Can the Government Cure Market Failure Due to Asymmetric Information, or Are Lemons Here to Stay?
Lemons Problem
The situation in which consumers, who do not know details about the quality of a product, are willing to pay no more than the price of a low-quality product, even if a higher quality product at a higher price exists

70. Lemons will tend to be overpriced.
Policy Example: Can the Government Cure Market Failure Due to Asymmetric Information, or Are Lemons Here to Stay?
Lemons will tend to be overpriced.
Quality used cars will be underpriced.

71. Issues and Applications: Has the U.S. Economy Become More Competitive?
Groundwork for greater competition: deregulation in the 1970s and 1980s
Trying to measure overall competition
A competition index shows the U.S. economy to be becoming more competitive

72. Issues and Applications: Have “Greedy” Companies Been Able to Avoid Serious Competition?
Source: John Duca and David BanHoose, “Has Greater Competition Restrained Inflation?” Southern Economic Journal, January 2000.
Figure 23-12

73. Summary Discussion of Learning Objectives
The characteristics of a perfectly competitive market structure
Large number of buyers and sellers
Homogeneous product
No barriers to entry and exit
Buyers and sellers have equal access to information

74. Summary Discussion of Learning Objectives
How a perfectly competitive firm decides how much to produce
Economic profits are maximized when marginal cost equals marginal revenue above minimum average variable cost

75. Summary Discussion of Learning Objectives
The short-run supply curve of a perfectly competitive firm
The rising part of the marginal cost curve above minimum average variable cost
The equilibrium price in a perfectly competitive market
A price at which the total amount of output supplied by all firms is equal to the total amount of output demanded by all buyers

76. Summary Discussion of Learning Objectives
Incentives to enter or exit a perfectly competitive industry
Economic profits induce entry of new firms
Economic losses will induce firms to exit the industry

77. Summary Discussion of Learning Objectives
The long-run industry supply curve and constant-, increasing-, and decreasing-cost industries
The relationship between price and quantity after firms have been able to enter or exit the industry
Constant-cost industry
Horizontal long-run supply curve
Increasing-cost industry
Upwards-sloping long-run supply curve
Decreasing-cost industry
Downward-sloping long-run supply curve