1. Perfect Competition Topic 5

2. Characteristics Pure Competition large number of sellers & buyers homogenous (identical) products low barriers to entry (free entry and exit from the industry) Perfect Competition large number of sellers & buyers homogenous (identical) products low barriers to entry perfect market knowledge perfect mobility of FoP’s Lead to faster adjustment

3. Price takers & Price makers Demand curve for a Price taker Demand curve for a Price maker

4. Demand curve for a Price taker The demand curve facing a perfectly competitive firm is perfectly elastic, meaning that the firm can sell as many units as it wants at the market price, but cannot sell any quantity if it charges more than the market price. The firm has no market power, no pricing power at all. It is just a small player in a large market….. It is a price taker.

5. Demand curve for a Price maker Downward sloping. It is just matter of how steep the curve is. The more market power a firm has, the steeper is the demand curve. The characteristic of a downward sloping demand curve is that, normally, if a firm raises the price of its product, it needs not lose all its customers, and if it wants to sell more, it has to cut price.

6. Demand curve for Individual firm under PC P = AR = MR Firm’s D curve Market D curve

7. Revenue Concepts under PC Total revenue (TR): Total number of dollars (or dong) received by a firm from the sale of a product. TR = P x Q Average revenue (AR): Total revenue per unit of a product sold AR = TR/Q = (P x Q) / Q = P Marginal Revenue (MR): Additional revenue received resulting from the sale of an extra unit of output MR = = = P ΔTR ΔQ P. ΔQ ΔQ

8. $131 131 131131131131131131131131131131 0 1 2345678910 $ 0 131262393524655786917104811791310 ]$131131131131131131131131131131 ] ] ] ] ] ] ] ] ]ProductPrice (Average (Average Revenue) Revenue) TotalRevenueMarginalRevenue QuantityDemanded(Sold)

9. TR Price, average and marginal revenue, total revenue (dollars) P Quantity demanded (sold) 1 2 3 4 5 6 7 8 9 10 917 9177866555243932621310 D = MR P = AR = MR

10. Profit Maximisation in the Short Run Two approaches to profit maximisation: Total Revenue minus Total Cost Approach Marginal Revenue, Marginal Cost Approach

11. IMPORTANT! Rules for Profit Maximisation Optimum output where: TR – TC = largest or Optimum output where: MR = MC –or MR closest to MC but MR > MC –MC cuts MR curve from below

12. Total Revenue – Total Cost Approach (Price = $131) 0 1 2 3 4 5 6 7 8 9 10 Total Cost Total Product Total Fixed Cost Total Variable Cost Total Revenue Profit $ 100 100 $ 0 90 170 240 300 370 450 540 650 780 930 $ 100 190 270 340 400 470 550 640 750 880 1030 $ 0 131 262 393 524 655 786 917 1048 1179 1310 – $100 – 59 – 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280

13. 0 1 2 3 4 5 6 7 8 9 10 100 0 90 170 240 300 370 450 540 650 780 930 100 190 270 340 400 470 550 640 750 880 1030 ] ] ] ] ] ] ] ] ] ] Total Cost Total Product Total Fixed Cost Total Variable Cost Marginal Cost Total Economic Prof./Loss Price = Marginal Revenue Profit Maximisation: MR, MC Approach 90 80 70 60 70 80 90 110 13 0 15 0 $ 131 131131131131131131131131131 – $100 – 59 – 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280

14. fig OO S D (a) Industry P$ Q (millions) PePe (b) Firm AR D = AR = MR MC QeQe Short-run equilibrium of industry and firm under Perfect Competition Q (thousands) Copyright 2001 Pearson Education Australia

15. IMPORTANT! Rules for Profit Maximisation Optimal output is where MR = MC  or MR closest to MC but MR > MC  MC cuts MR curve from below

16. IMPORTANT ! Rules for Profit maximization Short Run P ≥ AVC In the short run, fixed costs will be incurred whether or not the firm produces. So this means that total revenue must be at least equal to total variable cost for the firm to continue producing. If P < AVC, firm should shut down

17. IMPORTANT ! Rules for Profit maximization Long Run P ≥ ATC In the long run, firms have the option of closing down and going out of business, so total revenue must at least cover total costs ( all costs ). If P < ATC, firm should shut down

18. fig OO S D (a) Industry P$ Q (millions) PePe (b) Firm AR D = AR = MR MC QeQe ATC AC SR Profit maximisation under Perfect Competition Q (thousands) Copyright 2001 Pearson Education Australia

19. fig OO S D (a) Industry P$ Q (millions) PePe (b) Firm AR D = AR = MR MC QeQe ATC AC SR Profit maximisation under Perfect Competition Q (thousands) Copyright 2001 Pearson Education Australia

20. fig OO (a) Industry P$ P1P1 Q (millions) S D (b) Firm AR 1 D 1 = AR 1 = MR 1 MC QeQe ATC AC SR Loss minimisation under Perfect Competition Q (thousands) Copyright 2001 Pearson Education Australia AVC

21. fig Short-run shut-down point OO (a) Industry P$ P2P2 Q (millions) S D2D2 (b) Firm AR 2 D 2 = AR 2 = MR 2 MC ATC AVC Q Copyright 2001 Pearson Education Australia Q1Q1

22. Long run Equilibrium under PC Under PC  P = min. ATC = MR = MC  why?

23. fig Long-run equilibrium under PC OO D (a) Industry P$ Q (millions) P1P1 (b) Firm ATC AR 1 S1S1 D1 D1 Q (thousands) Copyright 2001 Pearson Education Australia

24. fig OO S1S1 D (a) Industry: As firms making supernormal profits, new firms will enter the industry. S curve shifts to right. Price falls. P$ Q (millions) P1P1 (b) Firm AR 1 ATC PLPL AR L QLQL SeSe D1D1 DLDL Long-run equilibrium under PC Q (thousands) Copyright 2001 Pearson Education Australia

25. fig OO S1S1 D (a) Industry: As firms making losses, some firms will leave the industry. S curve shifts to left. Price rises. P$ Q (millions) P1P1 (b) Firm AR 1 ATC PLPL AR L QLQL SeSe D1D1 DLDL Long-run equilibrium under PC Q (thousands) Copyright 2001 Pearson Education Australia

26. Long run Equilibrium.

27. Key characteristics of PC: – large number of sellers & buyers – identical products – freedom of entry & exit Implication (or conclusion) – Firms in PC cannot earn economic profits in the long run

28. Efficiency Allocative efficiency: Resources are allocated among firms and industries to obtain a mix of products most desired by society (consumers) Productive efficiency: The least costly methods of production are used (ie. goods are produced at the lowest possible costs)

29. Efficiency and Perfect Competition Price of product X = the relative worth of product X to the society (or the marginal benefit/satisfaction the society gets from an additional unit of X). Marginal Cost of product X is the cost of producing an additional unit of X (MC measures the sacrifice of other goods in using resources to produce more of X)

30. Efficiency and Perfect Competition Allocative efficiency:  P > MC : resources are under allocated  P < MC : resources are over allocated  P = MC : resources are best allocated/utilised Productive efficiency:  P = min ATC (For more details, read Jackson pp. 276 – 77)

31. Assessment of Perfect Competition Pros Productive efficiency: min AC (ie. firms produce at the least-cost output) Allocative efficiency: P = MC Consumer gains from low prices (ie. maximum consumer surplus) Speed of resource reallocation No power groups Cons Less scope for R&D Almost no product variety

32. Short-Run Supply Curve For the individual firm: the SR supply curve is the MC curve above the AVC curve For the entire industry: horizontal sum of firms’ MC curves above AVC

33. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) At every price, the MR = MC point changes the quantity being exchanged...

34. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) MR 3 Record the quantity being supplied for each price Q3Q3 P3P3

35. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) MR 3 Q3Q3 MR 2 At a lower price a lower quantity will be supplied Q2Q2 P2P2 P3P3

36. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) MR 3 Q3Q3 MR 2 Q2Q2 P2P2 P3P3 At a higher price a greater quantity will be supplied Q4Q4Q4Q4 Break-even (normal profit) point MR 4 P4P4

37. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) MR 3 Q3Q3 MR 2 Q2Q2 P2P2 P3P3 Q4Q4Q4Q4 Break-even (normal profit) point MR 4 Q5Q5 MR 5 P4P4 P5P5

38. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) MR 3 Q3Q3 MR 2 Q2Q2 P2P2 P3P3 Q4Q4Q4Q4 Break-even (normal profit) point MR 4 Q5Q5 MR 5 P4P4 P5P5 MR 1 P1P1 Firm should not produce unless revenue is at least able to meet AVC

39. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) MR 3 Q3Q3 MR 2 Q2Q2 P2P2 P3P3 Q4Q4Q4Q4 Break-even (normal profit) point MR 4 Q5Q5 MR 5 P4P4 P5P5 MR 1 P1P1 The Marginal Cost Curve at points above AVC represents the short-run supply curve

40. P = MC: Short-Run Supply Curve P Q MC AVC ATC Costs and revenues (dollars) MR 3 Q3Q3 MR 2 Q2Q2 P2P2 P3P3 Q4Q4Q4Q4 MR 4 Q5Q5 MR 5 P4P4 P5P5 MR 1 P1P1 Short-run supply curve (red)

41. P = MC: Short-Run Supply CurveP Q MC 1 AVC 1 If costs increase... the supply curve effectively shifts to the left MC 2 AVC 2

42. P = MC: Short-Run Supply CurveP Q MC 2 AVC 2 MC 1 AVC 1 If costs decrease... the supply curve effectively shifts to the right