Perfect Competition Asst. Prof. Dr. Serdar AYAN. Types of Markets u u Pure Competition or Perfect...

Perfect Competition

Asst. Prof. Dr. Serdar AYAN

Types of Markets

Pure Competition or Perfect Competition

Monopoly Duopoly Oligopoly Monopolistic Competition

Perfect Competition

Assumptions of Perfect Competition

Many independent firms Each seller is small relative to the whole

market Homogeneous (identical) product Easy entry and exit Perfect Information

Price Taking

The perfectly competitive firm is said to be a price-taker, because it takes the market price as given and has no control over the price. Why?...

If the firm tried to charge a higher price, it would lose all its business. Customers could go elsewhere to buy the same product for less.

Since the firm is very small, it can sell as much as it wants at the market price. So there’s no reason to charge a lower price.

The demand curve for the product of the perfectly competitive firm shows how much can be sold at specific prices. Let’s see what it would like to…

The firm can sell as little or as much as it wants at the market price. Suppose, for example, the market price is 5TL.

price

10 quantity

5TL

The firm can sell 10 units for 5TL.

price

20 quantity

5TL

The firm can sell 20 units for 5TL.

price

30 quantity

5TL

The firm can sell 30 units for 5TL.

price

40 quantity

5TL

The firm can sell 40 units for 5TL.

price

50 quantity

5TL

The firm can sell 50 units for 5TL.

price

quantity

5TL

So all these points are on the demand curve for the firm’s product.

price

quantity

5TL

Connecting these points, we have the demand curve for the firm’s product.

demand

price

quantity

market price

The demand curve for the perfectly competitive firm’s product is a horizontal line at the market price.

demand

Recall: Total Revenue

Total Revenue = Price x Quantity

TR = P x Q

Recall: Marginal Revenue (MR)

Marginal Revenue is the additional revenue earned from selling one additional unit of output.

MR = TR / Q

Comment

For ease of writing, instead of writing the “perfectly competitive” firm we will frequently write the “p.c.” firm.

The MR Curve for the p.c. Firm

For the p.c. firm, MR is equal to the market price. So MR is a horizontal line at the level of that price.

The demand curve for the p.c. firm is also a horizontal line at the level of the market price. So, for the p.c. firm, the demand curve and the MR curve are the same horizontal line.

price

quantity

market price

The demand curve (D) and the MR curve for the perfectly competitive

firm’s product.

D = MR

Optimal Output Level

Recall:

To maximize profit, the firm will produce at the output level where MR = MC.

So the firm will produce where the MR and MC curves intersect.

TL

Quantity

Draw your axes; label them quantity and TL.

Draw your ATC, AVC, and MC curves. (Make sure MC intersects ATC and AVC at the minimum.)

TL

Quantity

MC

ATC AVC

Draw the D = MR curve horizontal at the market price.

TL

Quantity

MC

ATC AVC

D = MR

If the market price is P1 , the quantity produced will be Q1.

TL

Quantity

MC

ATC AVC

D = MRP1

Q1

If the market price is P2 ,

the quantity produced will be Q2. TL

Quantity

MC

ATC

AVC

D = MRP2

Q2

If the market price is P3 ,

the quantity produced will be Q3. TL

Quantity

MC

ATC AVC

D = MRP3

Q3

If the market price is P4 , the quantity produced will be Q4.

TL

Quantity

MC

ATC AVC

D = MRP4

Q4

If the market price is P5 ,

the quantity produced will be Q5. TL

Quantity

MC

ATC AVC

D = MRP5

Q5

Shutdown Point

Price P5 was the minimum of the AVC curve (the shutdown point). If the price fell any lower than P5 the firm would produce no output.

The p.c. firm’s short run supply curve

The firm’s supply curve shows the quantity the firm will produce at each price.

The P, Q values we have shown, therefore, are points on the firm’s supply curve.

But those points are all on the firm’s MC curve.

So, the firm’s supply curve is the part of the MC curve that is above the minimum of the AVC curve.

The p.c. firm’s short run supply curve

TL

Quantity

MC

ATC

AVC

Supply

The market short run supply curve

To determine the total amount that all the firms will produce at each price, we simply add up the amounts that each of the firms will produce at that price.

Graphing Profit

A little trick for graphing a firm’s profit

Recall for a rectangle: Area = length . width

Arealength

width

We also know TR = P . Q. So, if we can find a rectangle whose length is P and whose width is Q, then its area must be total revenue.

P

Q

TR

To determine Total Cost, first remember ATC = TC / Q So, ATC . Q = TC

To determine Total Cost, first remember ATC = TC / Q So, ATC . Q = TC

Now, if we can find a rectangle whose length is ATC and whose width is Q, then its area is TC.

ATC

Q

TC

Then to determine profit, we just subtract the TC area from the TR area.

Graphing Profit:The six steps

Step 1 a. Draw your axes and label them Q and TL. ( Label the origin 0.)

TL

Quantity0

Step 1b. Draw the firm’s ATC curve. (If the price is below the minimum of ATC, you will also need to draw the AVC curve.)

TL

Quantity

ATCMC

P

0

Step 1 c. Draw the MC curve and D=MR curve. (For a positive profit, D must be at least partly above ATC.)

TL

Quantity

ATCMC

D = MRP

0

Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC.

TL

Quantity

ATCMC

D = MR

Q*

P

0

Step 3: Find your TR = PQ rectangle.

TL

Quantity

ATCMC

D = MR

Q*

P

0

Step 4: Determine ATC at the profit-maximizing output level.

TL

Quantity

ATCMC

D = MR

Q*

P

ATC

0

Step 5: Find your TC = ATC . Q rectangle.

TL

Quantity

ATCMC

D = MR

Q*

P

Step 6: Find profit = TR - TC.

TL

Quantity

ATCMC

D = MR

Q*

Pp r o f i t

You follow the same steps to draw a firm that is making a loss or breaking even (zero profits).

Let’s do a firm with a loss.

Step 1: Draw & label the curves & axes. For a loss, put D above the minimum of AVC & below the minimum of ATC.

TL

Quantity

ATCMC

D = MRP

0

AVC

Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC.

TL

Quantity

ATCMC

D = MRP

0 Q*

AVC

Step 3: Find your TR = PQ rectangle.

TL

Quantity

ATCMC

D = MRP

0 Q*

AVC

Step 4: Determine ATC at the profit-maximizing (or loss-minimizing) output level.

TL

Quantity

ATCMC

D = MRP

0 Q*

ATCAVC

Step 5: Find your TC = ATC . Q rectangle.

TL

Quantity

ATCMC

D = MRP

0 Q*

ATCAVC

Step 6: Find profit (or loss) = TR - TC.

TL

Quantity

ATCMC

D = MRP

0 Q*

l o s s AVC

A firm that is breaking even (zero profits)

Step 1: Draw & label the curves & axes. To break even, make D tangent to the minimum of ATC.

TL

Quantity

ATCMC

D = MRP

0

Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC.

TL

Quantity

ATCMC

D = MRP

0 Q*

Step 3: Find your TR = PQ rectangle.

TL

Quantity

ATCMC

D = MRP

0 Q*

Step 4: Determine ATC at the profit-maximizing output level.

TL

Quantity

ATCMC

D = MRATC = P

0 Q*

Step 5: Find your TC = ATC . Q rectangle.

TL

Quantity

ATCMC

D = MRATC = P

0 Q*

Step 6: Find profit = TR - TC.

TL

Quantity

ATCMC

D = MRATC = P

0 Q*