1. Chapter 8 Perfect Competition
Lecture Slides
Economics for Today Irvin B. Tucker
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2. What will I learn in this chapter?
This chapter discusses how competitive markets determine prices, output, and profits
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3. What is market structure?
A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry and exit
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4. What is perfect competition?
A market structure characterized by:
1. Large number of small firms
2. Homogeneous product
3. Very easy entry and exit
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5. What is meant by a large number of firms?
A large number of sellers condition is met when each firm is so small relative to the total market that no single firm can influence the market price
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6. What does homogeneous mean?
Goods that cannot be distinguished from one another. For example, farmer Brown’s wheat is identical to farmer Jones’s wheat.
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7. What conclusion can we make concerning a homogeneous product?
If a product is homogeneous, buyers are indifferent as to which seller’s product they buy
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8. What does very easy entry mean?
Perfect competition requires that a new firm faces no barriers to entry, such as financial, technical, or government-imposed barriers (licenses, permits, patents).
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9. © 2011 South-Western, a part of Cengage Learning
What is the result of a firm conforming to the perfect competition model?
The firm is a price taker, which means it is a seller that has no control over the price of the product.
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10. What determines price in perfect competition?
Market Demand and Market Supply
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11. S D Market Supply Market Demand Exhibit 1(a) Market Supply and Demand
140 S
120
100
Price per unit (dollars) E 80 70 60
Market Demand 40 20 D 20 40 60 80
100
Quantity of Output (thousands of units per hour)
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12. What determines the individual firm’s demand curve?
A horizontal line at the market price
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13. D 130 120 100 Demand 2 4 6 8 10 Exhibit 1(b) Individual firm demand 80
Price per unit (dollars) D 70 60 40 20 2 4 6 8 10
Quantity of output ( units per hour)
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14. Why is this horizontal line the firm’s demand curve?
If the firm charges more than this price, it will not sell anything, and it has no incentive to charge less than this price
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15. Why is the firm’s demand curve horizontal at the market price?
Because the firm can sell all it produces at the market price
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16. © 2011 South-Western, a part of Cengage Learning
Why does the firm have no incentive to charge less than the market price?
It can sell everything it brings to market at the market price
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17. What does the perfectly competitive firm control?
As a price taker, the only thing the firm controls is how many units it produces
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18. How many units should this firm produce?
The number of units that will maximize its profits, or minimize its losses
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19. What are the two methods to determine how many units to produce?
TR and TC method
MR and MC method
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20. © 2011 South-Western, a part of Cengage Learning
Using the total revenue-total cost method, where should a firm produce?
Where the distance between TR and TC is the greatest
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21. © 2011 South-Western, a part of Cengage Learning

22. TR TC Loss Exhibit 3(a) Total Revenue and Total Cost 800 700 600
500
Max profit=$205
Total Revenue and Total Cost (dollars)
400
300
200
Maximum profit output
100
Loss 9
Quantity of Output (units per hour) 22
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23. Quantity of Output (units per hour)
Exhibit 3(b) Profit or loss
250
200
150
Profit (dollars)
100
Profit= $205 50 9
Loss (dollars)
-50
Maximum profit output
Loss
-100
Quantity of Output (units per hour) 23
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24. What is marginal revenue (MR)?
The change in total revenue from the sale of one additional unit of output. ∆ ∆
MR = TR / 1 output
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25. What is marginal cost (MC)?
The change in total cost from the sale of one unit of output. ∆ ∆
MC = TC / 1 output
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26. © 2011 South-Western, a part of Cengage Learning
Using the marginal revenue and marginal cost method, where should a firm produce?
MR = MC
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27. Why should a firm continue to produce as long as MR > MC?
As long as MR is greater than MC, profit is being made on that last unit produced and sold.
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28. Why will a firm not produce any unit where MR < MC?
At any unit of output where MR < MC, the firm incurs a loss.
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29. Price and Cost per unit (dollars) Quantity of output (units per hour)
Exhibit 4(a) Price, Marginal Revenue, and Cost per Unit MC
120
100
MR=MC 80
Price and Cost per unit (dollars) MR 70
Profit=$205
ATC 60
AVC 40 20 2 4 6 8 9 10 12
Quantity of output (units per hour)
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30. Quantity of Output (units per hour)
Exhibit 4(b) Profit or loss
250
200
150
Profit (dollars)
100
Profit= $205 50 9
Loss (dollars)
-50
Maximum profit output
Loss
-100
Quantity of Output (units per hour)
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31. © 2011 South-Western, a part of Cengage Learning
Exhibit 5 Short-Run Loss Minimization Using the Marginal Revenue Equals Marginal Cost Method for a Perfectly Competitive Firm
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32. Price (MR) is below minimum average variable cost
Firm will shut down
Price (MR) is below minimum average variable cost
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33. What is the perfectly competitive firm’s short-run supply curve?
The firm’s marginal cost curve above the minimum point on its average variable cost curve
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34. Price & Cost per unit (dollars) Quantity of Output (units per hour)
Exhibit 6 The Short-Run Shutdown Point for a Perfectly Competitive Firm
120 MC
110
100 90 80 70
Price & Cost per unit (dollars)
ATC 60
AVC
Shutdown point 50 40 MR 25 10
Quantity of Output (units per hour)
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35. MC C B A Exhibit 7 The Firm’s Short-Run Supply Curve 120 Supply curve
100 C 90
MR3 80 70
Price per unit (dollars)
ATC 60 B
AVC 45
MR2 A 30
MR1 20 10
5.5 7 10
Quantity of output (units per hour)
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36. What is the perfectly competitive industry’s supply curve?
The horizontal summation of the MC curves of all firms in the industry above that lie above the minimum point on their AVC curves.
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37. Exhibit 8 Deriving the Industry Short-Run Supply Curve
Computech MC curve + Western Computer Co. = Industry Supply Curve MC MC S= ∑ MC 90 90 90
Price and marginal 40 40 40
cost per unit (dollars) 7 11 11 15 18 26
Quantity of Output (units per hour)
Quantity of Output (units per hour)
Quantity of Output (units per hour)
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38. Exhibit 9(a) Individual Short-Run Competitive Equilibrium 2 4 8 10 12
120 MC
100
Price and cost per unit (dollars) 80 E MR 60
Profit
ATC 40
AVC 20 6 2 4 8 9 10 12
Quantity of output (units per hour)
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39. Exhibit 9(b) Industry Short-Run Competitive Equilibrium S = MC
120
100 80
Price and Cost per unit (dollars) E 60 40 20 D 20 40 60 80
100
120
Quantity of output (thousands of units per hour)
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40. © 2011 South-Western, a part of Cengage Learning
What is a normal profit?
The minimum profit necessary to keep a firm in operation
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41. In the long-run, what happens when economic profits are made?
When firms make more than a normal profit, firms enter the industry; as supply increases, a downward pressure is put on prices
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42. In the long-run, what happens when losses are made?
When firms make less than a normal profit, firms leave the industry; as supply decreases, an upward pressure is put on prices
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43. In the long-run, where is equilibrium?
At the market price that enables firms to make a normal profit
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44. Exhibit 10 Long-Run Perfectly Competitive Equilibrium
SRATC
SRMC
105
LRAC 90 75 E
Price and cost per unit (dollars) 60 MR 45 30 15 1 2 3 4 5 6 7 8 9 10
Quantity of Output (units per hour)
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45. What equality exists at long-run perfectly competitive equilibrium?
P=MR=SRMC=SRATC=LRAC
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46. What different types of industries can exist in the long-run?
Constant-cost
Decreasing-cost
Increasing-cost
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47. What is a constant-cost industry?
An industry in which the expansion of industry output by the entry of new firms has no effect on the firm’s cost curves
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48. © 2011 South-Western, a part of Cengage Learning
What does the long-run supply curve look like in a constant-cost industry?
It is perfectly elastic, which is horizontal
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49. Increase in demand sets a higher equilibrium price
Entry of new firms increases supply
Initial equilibrium price is restored
Perfectly elastic long-run supply curve
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50. © 2011 South-Western, a part of Cengage Learning

51. What is a decreasing-cost industry?
An industry in which the expansion of industry output by the entry of new firms decreases the firm’s cost curves
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52. © 2011 South-Western, a part of Cengage Learning
What does the long-run supply curve look like in a decreasing-cost industry?
It is downward sloping
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53. Increase in demand sets a higher equilibrium price
Entry of new firms increases supply
Equilibrium price and ATC decrease
Downward sloping long-run supply curve
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54. © 2011 South-Western, a part of Cengage Learning

55. What is an increasing-cost industry?
An industry in which the expansion of industry output by the entry of new firms increases the firm’s cost curves
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56. © 2011 South-Western, a part of Cengage Learning
What does the long-run supply curve look like in a increasing-cost industry?
It is upward sloping
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57. Increase in demand sets a higher equilibrium price
Entry of new firms increases supply
Equilibrium price and ATC increase
Upward sloping long-run supply curve
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58. © 2011 South-Western, a part of Cengage Learning

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