1. Understanding Economics 2nd edition by Mark Lovewell and Khoa Nguyen
Chapter 5
Perfect Competition
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2. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.
Chapter Objectives
In this chapter you will:
Consider the four market structures, and the main differences among them.
Learn about the profit-maximizing rule and how perfectly competitors use it in the short run.
Examine how perfect competitive markets adjust in the long run, and the benefits they provide to consumers.
Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

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Market Structures
There are four main market structures:
perfect competition
monopolistic competition
oligopoly
monopoly
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Perfect Competition
Perfectly competitive markets have three main features:
many buyers and sellers
a standard product
easy entry and exit
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5. Monopolistic Competition
Monopolistically competitive markets have three main features:
many buyers and sellers
slightly different products
easy entry and exit
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6. Oligopoly and Monopoly
In an oligopoly a few businesses (protected by entry barriers) provide standard or similar products.
In a monopoly a single business (protected by entry barriers) provides a product with no close substitutes.
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Entry Barriers
There are six main entry barriers in oligopolies and monopolies:
increasing returns to scale
market experience
restricted ownership of resources
legal obstacles (such as patents)
market abuses (such as predatory pricing)
advertising (which is most common in oligopolies)
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Market Power
Market Power:
is a business’s ability to affect the price it charges
varies with market structure, such that monopolists have the most and perfect competitors have the least
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9. Attributes of Market Structures Figure 5.1, Page 120
Perfect Competition
very many
always
very easy
none
farming
Monopolistic
Competition
many
never
fairly easy
some
restaurants
Oligopoly
few
sometimes
difficult
some
automobile
manufacturing
Monopoly
one
not
applicable
very
difficult
great
public
utilities
Numbers of
Businesses
Standard
Product
Entry and Exit of
New Business
Market Power
Example
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10. Practice Questions
Instructions: Identify the market structure in which each of the following sellers operates. a.) TTC: _____________ b.) Selling shares on the Toronto Stock Exchange: ______________ c.) Canadian Post: ___________ d.) Ford Automobile Company: _______ e.) A café in Toronto: ____________

11. Perfect Competitor’s Demand (a)
A perfect competitor has a demand curve different from the market demand curve.
The business’s demand curve is horizontal at the prevailing market price.
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12. Perfect Competitor’s Demand (b) Figure 5.2, page 122
Market Demand and Supply
Curves for T-Shirts
27 000 6
Quantity of T-Shirts per Day
Price ($ per T-Shirt)
Pure ‘n’ Simple T-Shirts’
Demand Curve 6
Quantity of T-Shirts per Day
Price ($ per T-Shirt) Sm Db Dm
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13. Average and Marginal Revenue

14. Revenue Conditions for a Perfect Competitor
Average revenue equals price, so that a perfect competitor’s average revenue curve is its horizontal demand curve.
A perfect competitor’s average revenue (price) is constant so that marginal revenue and average revenue are always equal.
Price (P) = Average Revenue (AR) = Marginal Revenue (MR)
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15. Revenues for a Perfect Competitor Figure 5.3, page 123
Price
(P)
($ per T-shirt)
Revenue Schedules for Pure ‘n’ Simple T-Shirts
Quantity
(q)
(T-Shirts per day)
Total Revenue
(TR)
(P x q)
Marginal Revenue
(MR)
(ΔTR x Δq)
Average Revenue
(AR)
(TR x q) -- 6 80
200
250
270
280
480
1200
1500
1620
1680
480/80 = 6
720/120 = 6
300/50 = 6
120/20 = 6
60/10 = 6
480/80 = 6
1200/200 = 6
1500/250 = 6
1620/270 = 6
2680/280 = 6
Revenue Curves for Pure ‘n’ Simple T-Shirts 6
Quantity of T-Shirts per Day
$ per T-Shirt
Db = AR = MR
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16. The Profit-Maximizing Rule
The profit-maximizing rule states that profit is maximized when marginal revenue = marginal cost:
Output should be increased if marginal revenue exceeds marginal cost.
Output should be decreased if marginal cost exceeds marginal revenue.

17. Profit Maximization for a Perfect Competitor Figure 5.4, page 125
Total
Product
(q)
Price
(P)
(=AR)
Marginal
Revenue
(MR)
Cost
(MC)
(ΔTC/Δq)
Average
Variable Cost
(AVC)
(VC/q)
Profit Maximization Table for Pure ‘n’ Simple T-Shirts
(AC)
(TC/q)
(TR)
(TC)
Profit
(TR - TC) 80
200
250
270
280 6
1.75
1.50
1.70
1.98
2.29
480
1200
1500
1620
1680
825
965
1125
1250
1360
1465
-825
-485 75
250
260
215 6
1.75
1.33
2.50
5.50
10.50
12.06
5.63
5.00
5.04
5.24
Profit Maximization Graph for Pure ‘n’ Simple T-Shirts
Quantity of T-Shirts per Day
$ per T-Shirt
6.00 MC a
Db = MR = AR
Profit = $260 AC
5.04 b
The highest positive (or lowest negative) profit corresponds to the profit maximizing quantity. The owner should subtract the total cost from the total revenue to get the total profit.
AVC
270
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18. The Breakeven and Shutdown Points
The breakeven point is where a business breaks even while maximizing profit:
For a perfect competitor this occurs where price = minimum average cost.
The shutdown point is the lowest price at which a business will choose to operate in the short run:
It occurs where price = minimum average variable cost.
When price exceeds average cost (AC) at the profit-maximizing output, the business enjoys a short-run economic profit.
If the price is less than the average cost (AC), the business suffers a loss, or negative profit.
Business’s shut down point: Total Revenue (TR) = Variable Cost (VC)
(P X q) = (AVC X q)
(P) = minimum AVC
Recall that as long as variable costs do not exceed total revenue, the company should stay in business; if the variable costs begin to exceed total revenue, the company should shut down.
If the business is at a profit-maximizing profit output where price and average cost are equal, the business is making no economic profit and is said to be at its breakeven point.

19. A Perfect Competitor’s Supply Curve
A perfect competitor’s supply curve is its marginal cost curve above the shutdown point.
The market supply curve can be found by horizontally adding the supply curves for all the businesses in the industry.
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20. Supply Curve for a Perfect Competitor Figure 5.5, page 127
Supply Curve for Pure ‘n’ Simple T-Shirts
5.00
Quantity of T-Shirts per Day
$ per T-Shirt
6.00
270
1.40
1.50
200
250
Supply Schedule for
Pure ‘n’ Simple T-Shirts
Price
(P)
($ per T-Shirt
Quantity
Supplied
(q)
(T-Shirts per day)
MC(=Sb) a
MR1 AC b
MR2
6.00
5.00
1.50
1.40
270
250
200
AVC c d
At point a on the graph, price > average cost (AC), and positive economic profits are made.
Point b is the breakeven point, where price=AC.
At lower prices, the business makes a loss.
Point c is the business shutdown point, where P = AVC
Below the shutdown point – for example, at point d – average variable costs would exceed price.
The marginal cost curve (MC) above point c is the business’s supply curve (Sb), the highlighted part of the curve
Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

21. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.
Supply Curves for a Perfectly Competitive Business and Market Figure 5.6, page 129
Business and Market Supply Schedules for T-Shirts
Price
(P)
($ per T-Shirt)
Quantity Supplied
(q)
(Sb)
(Sm)
(T-Shirts per day)
6.00
5.00
1.50
270
250
200
27 000
25 000
20 000
Supply Curve for
Pure ‘n’ Simply T-Shirts
5.00
Quantity of T-Shirts per Day
Price ($ per T-Shirt)
6.00
270
250
200
1.50
Supply Curve for T-Shirt Market
5.00
Quantity of T-Shirts per Day
Price ($ per T-Shirt)
6.00
27 000
25 000
20 000
1.50 Sb Sm
The business’s supply curve shows that quantity of output supplied by the business at every possible price.
If price moves below the shutdown point (point c), t-shirts will no longer be in business, and its output will fall to zero.
Hence, only part of the marginal cost curve above this point is the business’s supply curve.
Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

22. Perfect Competition in the Long Run
Entry and exit by businesses in the long run drives a perfectly competitive market to the breakeven point:
businesses enter markets where economic profits are made so that supply shifts right and price falls
businesses leave markets where economic losses are made so that supply shifts left and price rises
Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

23. You have 20 minutes to complete Practice Questions 2-3.
Then we will take up the questions.

24. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.
Long-Run Equilibrium for a Perfectly Competitive Business Figure 5.7, page 130
Pure ‘n’ Simply T-Shirts 5
Quantity of T-Shirts per Day
$ per T-Shirt 6
270
250
T-Shirt Market
Quantity of T-Shirts per Day
$ per T-Shirt
30 000
27 000
25 000 5 6 MC S0 AC S1 d b a e MR c D1 D0
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25. The Benefits of Perfect Competition
Perfectly competitive markets in long-run equilibrium meet two conditions that benefit consumers:
minimum-cost pricing (price = minimum average cost)
marginal-cost pricing (price = marginal cost)
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26. Prophet of Capitalism’s Doom
According to Karl Marx’s theory of exploitation
a product’s price is based on the amount of labour that goes into producing it
capitalists cut costs by minimizing workers’ wages and by maximizing the length of the workday
capitalists keep any surplus value which is the excess of their revenues over their costs
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27. You have 10 minutes to complete Practice Questions 1.
Then we will take up the questions.

28. Marx’s Theory of Exploitation Figure A, Page 135
Creation of Surplus Value
(when producing 2 shirts or 1 suit)
Creation of Surplus Value 80
Daily Wage
Value produced ($ per day) 20 40 60
$50 Wage
$50
$10
$20
$80 2 5
$30 Wage
$30
$10
$40
$80 4 3
W = 50
M = 10
SV = 10
SV = 40
W = 10
W = 30
Daily Wage
Materials and
machine wear
and tear (M)
Surplus Value (SV)
Total Value
Exploitation Rate
(SV/W)
$50
$30
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29. Understanding Economics 2nd edition by Mark Lovewell
Chapter 5
The End
Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.