Chapter 8
Perfect Competition
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western
Market structure
• The characteristics of a market that
influence how trading takes place
1. How many buyers and sellers?
2. Products: standardized or significantly
different?
3. Barriers to entry/exit ?
2
Market structure
• Types of markets
– Perfect competition
– Monopoly
– Monopolistic competition
– Oligopoly
3
Perfect Competition
• Many buyers and sellers
– no individual decision maker can
significantly affect the price of the
product
• Standardized product
– buyers do not perceive differences
between the products
• Sellers can easily enter/exit the market
– no significant barriers to discourage new
entrants
4
Is Perfect Competition Realistic?
• Many markets - while not strictly
perfectly competitive - come reasonably
close
• Perfect competition can approximate
conditions and yield accurate-enough
predictions in a wide variety of markets
5
The Competitive Firm’s Demand Curve
• Horizontal demand curve – perfectly
elastic - at the market price
• Output is standardized
• Price taker
– The price of its output is given
• Decision
– How much output to produce and sell
6
The Competitive Firm’s Demand Curve
• Figure 1 The Competitive Industry and Firm
1. The intersection of the market supply
and the market demand curve…
Price per
Ounce
Market
3. The typical firm can sell all it
wants at the market price…
Price per
Ounce
Firm
S
$400
$400
D
Ounces of Gold per Day
2. determines the
equilibrium market price
Demand
Curve Facing
the Firm
Ounces of Gold per Day
4. so it faces a horizontal
demand curve.
7
Cost and Revenue Data
• Marginal revenue curve
– The demand curve facing the firm
– A horizontal line at the market price
8
Profit Maximization
• Figure 2 Profit Maximization in Perfect Competition (a) TR-TC
Dollars
TR
$2,800
TC
Profit = TR-TC
Maximum Profit
per Day = $700
2,100
550
Slope = 400
1
2
3
4
5
6
7
8
9
10
Ounces of Gold per Day
9
Profit Maximization
• Figure 2 Profit Maximization in Perfect Competition (b) MR=MC
Dollars
Profit maximization
MR=MC
MC
$400
d = MR
1
2
3
4
5
6
7
8
9
10
Ounces of Gold per Day
10
Profit Maximization
•
•
•
•
Total Profit = TR – TC
MR>MC – increase output
Maximize profit: MR=MC
Measuring Total Profit
– Profit per unit = P – ATC
• If P > ATC – the firm earns profit
• If P < ATC – the firm suffers a loss
11
Measuring Profit or Loss
• Figure 3 Measuring Profit or Loss
a) Economic Profit
Total profit = profit per unit *Q
Dollars
ATC
Profit per unit=revenue per unit - cost per unit
Profit per Ounce ($100)
MC
d = MR
$400
300
MR=MC
Q=7
1
2
3
4
5
6
7
8
Ounces of
Gold per Day
12
Measuring Profit or Loss
• Figure 3 Measuring Profit or Loss
Dollars
b) Economic Loss
Total loss = loss per unit *Q
Loss per unit= cost per unit - revenue per unit
Loss per Ounce ($100)
MC
MR=MC
Q=5
ATC
$300
200
d = MR
1
2
3
4
5
6
7
8
Ounces of
Gold per Day
13
The Firm’s Short-Run Supply Curve
• The firm
– takes the market price as given
– decides how much output to produce at
that price
• Profit-maximizing output level: P=MC
– As price of output changes, firm will slide
along its MC curve in deciding how much
to produce
– Exception – If the firm is suffering a loss
large enough to justify shutting down
14
The Firm’s Short-Run Supply Curve
• Figure 4 Short-Run Supply Under Perfect Competition
(a)
(b)
Price per
Dollars
ATC
Bushel
MC
Curve
$3.50
d1=MR1
$3.50
2.50
2.00
d2=MR2
d3=MR3
2.50
2.00
d4=MR4
d5=MR5
1.00
0.50
1.00
0.50
AVC
1,000
4,000
7,000
2,000
5,000
Firm's Supply
Bushels
per Year
2,0004,000 7,000
5,000
Bushels
per Year
15
The Shutdown Price
• Price at which a firm is indifferent
between producing and shutting down
• If P>AVC – produce
• If P<AVC – shut down
• Firm’s supply curve
– Is its MC curve for all prices above AVC,
and a vertical line at zero units for all
prices below AVC.
16
Competitive Markets in the Short- Run
• Fixed number of firms in industry
• Market supply curve
– Quantity of output - all sellers in a market
will produce at different prices
– Add up the quantities of output supplied
by all firms in the market at each price
17
Competitive Markets in the Short- Run
• Figure 5 Deriving The Market Supply Curve
1. At each price . . .
3.The total supplied by all firms at different
prices is the market supply curve.
Market
Firm
Price per
Bushel
Firm's Supply Curve
Price per
Bushel
$3.50
$3.50
2.50
2.00
2.50
2.00
1.00
0.50
1.00
0.50
2,000 4,000
7,000 Bushels
per Year
5,000
2. the typical firm supplies the
profit-maximizing quantity.
Market Supply
Curve
400,000 700,000 Bushels
per Year
200,000 500,000
18
Short-Run Equilibrium
• Competitive firms can earn economic profit,
or suffer an economic loss
• The market
– sums buying and selling preferences of
individual consumers and producers, and
determines market price
• Each buyer and seller
– Takes market price as given
– Is able to buy or sell the desired quantity
19
Perfect Competition
• Figure 6 Perfect Competition
Individual
Demand
Curve
Quantity
Demanded at
Different Prices
Quantity
Supplied at
Different Prices
Added together
Market
Demand
Curve
Individual
Supply
Curve
Added together
Quantity Demanded
by All Consumers at
Different Prices
Quantity Supplied by
All Firms at Different
Prices
Market
Supply
Curve
Market Equilibrium
P
Quantity
Demanded by
Each Consumer
S
D
Q
Quantity Supplied
by Each Firm
20
Perfect Competition
• Figure 7 Short-Run Equilibrium in Perfect Competition
1. When the demand curve is D1 and
market equilibrium is here . . .
Price per
Bushel
Market
S
$3.50
2.00
D1
2. the typical firm operates here, earning
economic profit in the short run.
Firm
Dollars
MC ATC
d1
$3.50
Loss per Bushel
at p = $2
2.00
d2
Profit per Bushel
at p = $3.50
D2
400,000 700,000
3. If the demand curve shifts to
D2 and the market equilibrium
moves here . . .
Bushels
per Year
Bushels
per Year
4. the typical firm operates here and
suffers a short-run loss.
4,000
7,000
21