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1
Perfect Competition
These slides supplement the textbook, but should not replace reading the textbook
2
What ismarket structure?
Important features of a market, such as the number of firms, product uniformity, ease of entry, and forms of competition
3
What are the four types of Markets?
Perfect Competition Monopolistic Competition Oligopoly Monopoly
4
What is aperfectly competitive
market?homogeneous product many buyers and sellers no one has much market
power easy entry & easy exit can sell all bring to market
5
What is a price taker?
A firm that faces a given market price and whose actions have no effect on that market price
6
Why is a firm that is part of a perfectly
competitive market a price taker?
Because if the firm charges higher than the market price it will not sell even one unit
7
Pri
ce p
er u
nit
Quantity per period
Market Equilibrium in Perfect Competition
D
S
0Exhibit 1a
Surplus
Shortage
8
The Firm’s Demand Curve in Perfect Competition
Market quantity
P S
DIndividual quantity
P
d
8
9
How does the firm maximize profit?
By finding the rate of output that makes total revenue minus total cost as large as possible
10
7
Maximum economic profit = $12
12
TRTC$60
48
15Tot
al d
olla
rs
Quantity per period
Short-Run Profit MaximizationPanel A: TR minus TC
151050Exhibit 3a
11
What is marginal revenue?
The change in total revenue resulting from a one-unit change in sales
12
What is marginal cost?
The change in total cost resulting from a one-unit change in sales
13
At what point are profits maximized?At the level of output where MR = MC, or the last unit of output where MR > MC
14
Q MR TR TC MC ATC Profit
10 5 50 40.00 2.75 4.00 10.00 11 5 55 43.25 3.25 3.93 11.7512 5 60 48.00 4.75 4.00 12.0013 5 65 54.50 6.50 4.19 10.5014 5 70 64.00 9.50 4.57 6.00
Exhibit 2
Maximizing Profits in the Short-Run
15
Why does MR = P in Perfect Competition?
Because no matter how many units are brought to market, the firm can sell all of them at the market price
16
What isaverage revenue?
Total revenue divided by output
TR / Q
17
Why does AR=P in all markets?
Because each unit is sold for the same price
at one point in time
18
Tot
al d
olla
rs
Quantity per period
Short-Run Profit MaximizationPanel B: MR equals MC
120
$5$4
Profit
d = MR = AR ATCMCea
Exhibit 3b
19
At what point are losses minimized?
At the level of output where MR = MC, or the last unit of output where MR > MC
20
Q MR TR TC MC ATC Loss
8 3 24 35.25 1.50 4.41 -11.25 9 3 27 37.25 2.00 4.14 -10.2510 3 30 40.00 2.75 4.00 -10.0011 3 33 43.25 3.25 3.93 -10.2512 3 36 48.00 4.75 4.00 -12.00
Exhibit 4
Minimizing Losses in the Short-Run
21
What will a firm do if average variable cost exceeds price at every
level of production?Shut down
22
$4030
15Tot
al d
olla
rs
Quantity per period
Minimizing Short-Run Losses
151050
Minimum economic loss = $10
TRTC
Panel A: TC and TR
Exhibit 5a
23
$4.003.002.50
151050
Dol
lars
per
un
it
Quantity per period
Minimizing Short-Run Losses
MC
AVC
ATC
d = MR = AR
Panel B: MC equals MR
Exhibit 5b
Loss
24
What is the firm’s short-run supply curve?
A curve that indicates the quantity a firm supplies at each price in the short run
25
Dol
lars
per
un
it
Quantity per period
Summary of Short-Run Output Decisions
p1
p2
p3
p4
p5
q2 q3 q4 q5
MCATC
AVC
Shutdown point
Break-even point
d1
d2
d3
d4
d5
Exhibit 5
26
What is the firm’s short run supply curve?
That portion of its MC curve which lies above its AVC curve
27
Tot
al d
olla
rs
Quantity per period
Relationship between Short-Run Profit Maximization and Market Equilibrium
Panel A: Firm
121050
$54 Profit d=MR
ATCMC = s
Exhibit 8a
AVC
28
What is the industry’s short-run supply curve?
A curve that indicates the quantity all firms in an industry supply at each price in the short run
29
Aggregating Individual Supply to Form Market Supply
Panel A: Firm AP
rice
per
un
it
Quantity per period
p'
p
10 200
SA
Exhibit 7a
30
Aggregating Individual Supply to Form Market Supply
Panel B: Firm BP
rice
per
un
it
Quantity per period
p'
p
10 200
SB
Exhibit 7b
31
Aggregating Individual Supply to Form Market Supply
Panel C: Firm CP
rice
per
un
it
Quantity per period
p'
p
10 200
SC
Exhibit 7c
32
Aggregating Individual Supply to Form Market Supply
Panel D: Industry, or market supply
Pri
ce p
er u
nit
Quantity per period
p'
p
30 60
SA + SB + SC = S
0Exhibit 7d
33
Pri
ce p
er u
nit
Quantity per period
Relationship between Short-Run Profit Maximization and Market Equilibrium
Panel B: Industry, or market
12,0000
$5
D
MC = S
Exhibit 8b
34
What is economic profit in the long run?
Zero
35
Dol
lars
per
un
it
Quantity per period
Long-Run Equilibrium for the Firm
q0
p d
ATCMCLRAC
e
Exhibit 9a
36
Pri
ce p
er u
nit
Quantity per period
Long-Run Equilibrium for the Industry
Q0
p
D
S
Exhibit 9b
37
What is the long-run industry supply curve?A curve that shows the relationship between price and quantity supplied once firms fully adjust to any change in market demand
38
What is an increasing-cost
industry?An industry that faces higher per-unit production costs as industry output expands in the long run
39
Upward sloping
What is the shape of the long-run industry supply
curve in an increasing cost industry?
40
What is production efficiency?
The condition that exists when output is produced with the least-cost combination of inputs, given the state of technology
41
What is allocative efficiency?The condition that exists when firms produce the output that is most preferred by consumers
42
What is the the marginal cost of each
good equal to?The marginal benefit consumers derive from that good
43
What is consumer surplus?
The difference between the maximum amount that a consumer is willing to pay for a given quantity of a good and what the consumer actually pays
44
What is producer surplus?
The amount by which total revenue from production exceeds total variable cost
45
Consumer Surplus and Producer Surplus for a Competitive Market in the
Short RunD
olla
rs p
er u
nit
Quantity per period
5
$10
0
10,000 20,00012,000
6
e
m
S
D
Consumer surplusProducer surplus
Exhibit 14
46
END
47
Appendix
48
What is a constant-cost industry?
An industry that can expand or contract without affecting the long-run per-unit cost of production
49
What is the shape of the long-run industry
supply curve?horizontal
50
Dol
lars
per
un
it
Quantity per periodq0
p d
ATC
MC
LRAC
d'Profit
q'
p'
Panel A: the Firm
Exhibit 10a
Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry
51
Dol
lars
per
un
it
Quantity per period
Long-Run Adjustment to a Decrease in Demand in a Constant Cost
Industry for the Firm
q0
p d
ATCMCLRAC
e
p''
q''
d''Loss
Exhibit 11a
52
Dol
lars
per
un
it
Quantity per period
Long-Run Adjustment to an Increase in Demand in a Constant Cost Industry
Qb0
p
Qc
p'
Qa
S*
S'S
D'D
ab
c
Exhibit 10b
53
Dol
lars
per
un
it
Quantity per periodQf0
p''
Qa
p
Qg
S*
SS''
DD''
g a
f
Exhibit 11b
Long-Run Adjustment to a Decrease in Demand in a Constant Cost Industry
54
Pri
ce p
er u
nit
Quantity per periodQb0
pa
pc
pb
QcQa
S*S'SD
D'a
bc
Exhibit 12b
Long-Run Adjustment to a Increase in Demand in an Increasing Cost Industry
55
Dol
lars
per
un
it
Quantity per periodqb0
pa da
ATC
MC'
a
pc
q
dcc
pb
MC
ATC'dbb
Exhibit 12a
Long-Run Adjustment for the firm to an Increase in Demand in an
Increasing Cost Industry
56
What is a decreasing-cost
industry?The rare case in which an industry faces lower per-unit production costs as industry output expands in the long run
57
Downward sloping
What is the shape of the long-run industry supply
curve in a decreasing cost industry?
58
Dol
lars
per
un
it
Quantity per period
A Decreasing-Cost Industry Adjusts to an Increase in Demand
0
papc
QcQa
S*
S'S
DD'
a
b
c
Exhibit 13
