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*
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