Market+Structure Perfect+Competition

8/8/2019 Market+Structure Perfect+Competition

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MARKETSTRUCTURE:PerfectCompetition


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Purpose of thischapter

To explain howcompetitive markets

determine prices,output, and profits


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Structure of the

MarketThe process by which price

and output are determinedin the real world is stronglyaffected by the structure ofthe market


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Market structureA classification system for

the key traits of a market,including the number offirms, the similarity of theproducts they sell, and theease of entry and exit


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Types of Market

Structure1.Perfect Competition

2.Monopoly

3.Monopolistic Competition4.Oligopoly

Types 2, 3 and 4 are referred to as imperfectcompetition


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Perfect competition

1. many small firms

2. homogeneous product

3. very easy entry and exit

4. price taker

5.economic agents haveperfect knowledge of market

conditions


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Homogeneous Product

Goods that cannot be

distinguished fromone another; for

example, one potatocannot bedistinguished from

another potato


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Seller is a Price taker

A seller that has nocontrol over the priceof the product it sells

He can not influence

the price


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Price determination inPC

Supply and Demand


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D

S

Market Supply and DemandP

Q


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What determines theindividual firmsdemand curve?A horizontal line atthe market price


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Individual firm demand

Q

P


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If the firm charges morethan this price, it will not

sell anything, and it hasno incentive to chargeless than this price


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Why does the firm

have no incentive tocharge less than the

market price?It can selleverything it bringsto market at themarket price


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What does theperfectly competitive

firm control?

The only thing it controlsis how many units itproduces.

It can not influence price.It has to sell at the

market-clearing price.


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How many units of theproduct should thisfirm produce?

The number of units

whereby it will maximizeits profits, or at leastminimize its losses


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There are two

methods todetermine how many

units to produce TR and TC

MR and MC


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The total revenue -total cost method

Where the distancebetween TR and TCis the greatest.Then profit can be

maximized


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Quantity of Output

TRMaximize Profit TC

TR,TC

QProfit Maximising Output


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Marginal Analysis to

determine the profit-

maximising level of output

By comparingMarginal Revenue and

Marginal Cost


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Marginal revenue

MR = TR / 1 outputChange in total revenue from

the sale of one additional unitof output


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Marginal cost

MC = TC / 1 outputChange in total cost from

producing one additional unitof output


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The marginal revenue and marginal costmethod to profit maximization

MR = MCThe firm maximizesprofit byproducing the output where

marginal revenueequalsmarginal cost


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Why should a firmcontinue to produce

as long as MR > MC?As long as MR is > than

MC, money is beingmade on that last unit


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Why will a firm notproduce that unitwhere MR < MC?

At the unit of output whereMR < MC, money is being

lost on that last unit


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ATC

AVC

MCP = MR = AR

Profit

Pric

e&

Co

stp

er

unit MR=MC

Profit maximising output


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ATCAVC

MC

P=MR=ARLoss

Pri

ce&

Co

stp

eru

ni t MR=MC

P

Q


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ATC

AVC

MC

P=MR=AR

Short-Run Shutdown

MR=MC

P

Q

Loss

Price&

Co

stp

er

unit


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Price (MR) is below

minimum averagevariable cost

Firm will shut down


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Shut down

If the price (average revenue)is below the minimum point on

the average variable costcurve, the MR = MC rule doesnot apply, and the firm shutsdown to minimize its losses.


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The perfectly competitive

firms short-run supply

curve

The perfectly competitive firmsshort-run supply curve is a

curve showing the relationship

between the price of a productand the quantity supplied in the

short run.


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The perfectly

competitive firms short-run supply curve

The firms marginal costcurve above the

minimum point on itsaverage variable costcurve


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AVC

MC

MR3

MR2MR1

Firms Short-Run Supply CurveP

Q


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The industrys supplycurve

The summation of theindividual firms MC

curves that lie abovetheir minimum AVCpoints


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The industrys

supply curveThe perfectly competitive

industrys short-run supply

curve is the horizontal

summation of the short-runsupply curves of all firms in

the industry

Industrys Supply Curve


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S = MCIndustrys Supply Curve

P

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Normal profitThe minimum

profit necessary tokeep a firm in

operation

I th l


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In the long-run,what happens when

economic profitsare made?

When firms make morethan a normal profit, firmsenter the industry.Assupply increases, adownward pressure is

put on prices


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In the long-run, what

happens whenlosses are made?When firms make less thana normal profit, firms leavethe industry. As supply

decreases, an upwardpressure is put on prices


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In the long-run, whereis equilibrium?

At the market pricethat enables firms tomake anormal profit


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long-run perfectlycompetitiveequilibrium

P = MR = SRMC =

SRATC = LRAC


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SATC

LRAC

SRMC

MR

Equilibrium

Long-Run Competitive EquilibriumP

Q


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Three different typesof industries can

exist in the long-run

Constant-cost Decreasing-cost Increasing-cost


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Constant-cost industry

An industry in which theexpansion of industryoutput by the entry of

new firms has no effecton the firms cost curves


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The long-run supplycurve in a constant-

cost industry

It is perfectly elastic,which is horizontal

I i d d t

I i d d


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Increase in demand sets ahigher equilibrium price


Entry of new firmsincreases supply


Initial equilibriumprice is restored

Initial equilibriumprice is restored

Perfectly elastic long-runsupply curve

Perfectly elastic long-runsupply curve


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A decreasing-costindustry

An industry in which the

expansion of industryoutput by the entry of

new firms decreasesthe firms cost curves


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The long-run supplycurve in a decreasing-cost industry

It is downward sloping

I i d d t


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Equilibrium priceand AC decreaseEquilibrium priceand AC decrease

Downward sloping long-runsupply curve

Downward sloping long-runsupply curve


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An increasing-costindustry

An industry in which theexpansion of industryoutput by the entry ofnew firms increases thefirms cost curves


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The long-run supplycurve in a increasing-cost industry

It is upward sloping

I i d d t

I i d d t


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Equilibrium priceand AC increaseEquilibrium priceand AC increase

Upward sloping long-runsupply curve

Upward sloping long-runsupply curve


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Summary


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Market structure consists of threemarket characteristics: (1) thenumber of sellers, (2) the nature

of the product, (3) the case ofentry into or exit from the market.


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Perfect competition is a marketstructure in which an individualfirm cannot affect the price of the

product it produces. Each firm inthe industry is very small relativeto the market as a whole, all thefirms sell a homogeneous

product, and firms are free toenter and exit the industry.


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A price-taker firm in perfect

competition faces a perfectlyelastic demand curve. It can sellall it wishes at the market-

determined price, but it will sellnothing above the given marketprice. This is because so many

competitive firms are willing tosell at the going market price.


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The total revenue-total costmethod is one way the firmdetermines the level of outputthat maximizes profit. Profit

reaches a maximum when thevertical difference between thetotal revenue and the total cost

curves is at a maximum.

P


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Quantity of Output

TRMaximize Profit TC

P

Q


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The marginal revenue equalsmarginal cost method is a secondapproach to finding where a firmmaximizes profits. Marginal

revenue is the change in totalrevenue from a one-unit changein output. Marginal revenue for a

perfectly competitive firm equalsthe market price.


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The MR = MC rule states that the

firm maximizes profit or minimizesloss by producing the outputwhere marginal revenue equals

marginal cost. If the price(average revenue) is below theminimum point on the averagevariable cost curve, the MR = MCrule does not apply, and the firmshuts down to minimize its losses.

ATC


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ATC

AVC

MC

P = MR = AR

Profit

Pr

ice&

Costp

er

unit MR=MC

tP


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ATCAVC

MC

P=MR=ARLoss

P

ric

e&

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stp e

runi t

MR=MCP

Q

Short Run ShutdownP t


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AVC

MC

P=MR=AR

Short-Run Shutdown

MR=MC

P

Q

Loss

P

ric

e&

Costp e

runit


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The perfectly competitive firmsshort-run supply curve is a curveshowing the relationship between

the price of a product and thequantity supplied in the short run.


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The individual firm always producesalong its marginal cost curve aboveits intersection with the averagevariable cost curve. The perfectly

competitive industrys short-runsupply curve is the horizontalsummation of the short-run supply

curves of all firms in the industry.

Industry EquilibriumP


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S = MCIndustry EquilibriumP

Q


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Long-run perfectly competitiveequilibrium occurs when the firmearns a normal profit byproducing where price equalsminimum long-run average costequals minimum short-runaverage total cost equals short-

run marginal cost.

Long-Run Competitive EquilibriumP


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SATC

LRAC

SRMC

MR

EquilibriumP

Q


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A constant-cost industry is anindustry whose total output canbe expanded without an increasein the firms average total cost.Because input prices remainconstant, the long-run supplycurve in a constant-cost industry

is perfectly elastic.


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A decreasing-cost industry is anindustry in which lower inputprices result in a downward-sloping long-run supply curve. As

industry output expands, thefirms average total cost curveshifts downward, and the long-run

equilibrium market price falls.


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An increasing-cost industry is anindustry in which input prices riseas industry output increases. As a

result, the firms average totalcost curve rises, and the long-runsupply curve for an increasing-cost industry is upward sloping.


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Market+Structure Perfect+Competition