1. Perfect Competition
Chapter 9
ECO 2023
Fall 2007

2. Market Structure Describes the important feature of a market such as
Number of suppliers
Product’s degree of uniformity
Ease of entry into the market
Forms of competition among firms
A firm’s decisions about how much to produce or what price to charge depend on the structure of the market

3. Market Models Pure Competition Pure Monopoly Monopolistic Competition
Oligopoly

4. Perfect Competitive Market
A market structure with many fully informed buyers and sellers of a standardized product and no obstacles to entry or exit of firms in the long run

5. Characteristics Many independent buyers and sellers
Buyers are small relative to the market
Standardized product – homogeneous
Price takers – individual firms exert no significant control over product price.
Free entry and exit into the industry

6. Perfectly Competitive Market
Demand under Perfect Competition
Firm’s demand is perfectly elastic therefore the demand curve is horizontal
PRICE TAKER
One and only price exists in the market and it is equilibrium price P D Q

7. Average Revenue
The firm’s demand schedule is also its average revenue schedule
Price per unit to purchaser is also revenue per unit or average revenue

8. Total Revenue
P X Q
Since price is constant, increase in sales of one unit leads to increase in total revenue = to price.
Each unit sold adds exactly its constant price to total revenue

9. Marginal Revenue
Is the change in total revenue that results from selling 1 more unit of output
This is the selling price since it is constant
Therefore: MR = AR = Price

10. Short Run Profit Maximization
Each firms tries to maximize economic profit
Short run – it has a fixed plant
Therefore output is changed through changes in variable inputs.
It adjusts its variable resources to achieve the output level that maximizes its profit.
Two ways to determine level of output at which a competitive firm will realize maximum profit or minimum loss
Compare total revenue to total cost
Compare marginal revenue to marginal cost
Both apply to all firms
Firms that ignore this strategy do not survive

11. Economic profit or loss
Example
Bushels per day
Total Fixed Costs
Total Variable costs
Total Cost
Total Revenue
Economic profit or loss Q
TFC
TVC TC
TR = P X Q where P =$131
TR-TC
$100 $0
-$100 1 90
190
131
-59 2
170
270
262 -8 3
240
340
393
+$53 4
300
400
524
+124 5
370
470
655
+185 6
450
550
786
+236 7
540
640
917
+277 8
650
750
1048
+298 9
780
880
1179
+299 10
930
1030
1310
+280

12. Graphically Total Cost Total Revenue & Total Cost Quantity Demanded
Maximum Economic Profit
Total Revenue
&
Total Cost
Total Cost
Quantity Demanded 9

13. Marginal Revenue Equals Marginal Cost
The change in total revenue from selling an additional unit
In perfect competition, marginal revenue is equal to the market price
The firm will increase production as long as each additional units adds more to total revenue than to cost
As long as marginal revenue exceeds marginal cost

14. Average Variable Costs
Graphically
Total Product
Average Fixed Costs
Average Variable Costs
Average Total Costs
Marginal Costs
Marginal Revenue
Economic Profit Q
AFC = TFC/Q
AVC
ATC MC
MR = P $ $
$ (100.00) $ 1 $ $ $
$ (59.00) $ 2 $ $ $
$ (8.00) $ 3 $ $ $ $ $ 4 $ $ $ 5 $ $ $ $ 6 $ $ $ 7 $ $ $ $ $ 8 $ $ $ $ $ 9 $ $ $ $ $ 10 $ $ $ $

15. Golden Rule of Profit Maximization
MR = MC

16. Perfectly Competitive Market
Short run economic profit
Demand = Marginal Revenue = Price =
Average Revenue $5 $4 12
Price MC
ATC
Profit
Quantity
Profit

17. Perfectly Competitive Market
Minimizing Short-Run Losses
An individual firm in perfect competition has no control over the market price
Price may be so low that a firm loses money no matter how much it produces
Can either produce at a loss
Temporarily shut down
Short run
A period too short to allow existing firms to leave the industry

18. Perfectly Competitive Market
Decision in the short run
Continue to produce
A firm will produce if
TOTAL REVENUE > VARIABLE COST
Shut down
A firm will shut down
TOTAL REVENUE < VARIABLE COST

19. Perfectly Competitive Market
Short run Losses
Demand = Marginal Revenue = Price =
Average Revenue $5 $4 12
Price MC
ATC
Loss
Quantity
Loss

20. Perfectly Competitive Market
Perfect Competition in the Long Run
If short run has ECONOMIC PROFIT
Firms enter the industry
Increase in supply
Price drops
Continues until NO ECONOMIC PROFIT in the long run
Price = Marginal Cost = Average Total Cost

21. Perfectly Competitive Market
Perfect Competition in the Long Run
If short run has ECONOMIC Loss
Firms leavethe industry
Decrease in supply
Price rises
Continues until NO ECONOMIC PROFIT in the long run
Price = Marginal Cost = Average Total Cost

22. Perfectly Competitive Market
Productive efficiency
The condition that exists when market output is produced using the least cost combination of inputs
Minimum average cost in the long run
Allocative efficiency
The condition that exists when firms produce the output most preferred by consumers
Marginal benefits = marginal cost