Perfect Competition
Econ 10
Holmes
Road Map
Costs
Definition
Graphs
Tables
Definition
Perfect Competition is the Industry Structure
characterized by
•many, many firms
•each firm has no independent effect on the market price
(price taker)
•homogeneous goods
•perfectly elastic demand (for a particular firm’s good)
Common examples:
produce stand
The demand for a particular
firm’s good
$
Firm
P
(Farmer Joe’s Tomatoes)
Market
(Tomatoes)
S
d
D
q
Q
Road Map
Costs
Definition
Graphs
Tables
Perfect Competition:
Generic Cost Curves
$
MC
ATC
AVC
Q
Perfect Competition:
Condition I: P>ATC
$
MC
ATC
D
AVC
Where
does
P=MC?
Q
Perfect Competition:
Condition I: P>ATC
$
MC
ATC
D
AVC
Q
Perfect Competition:
PROFIT
Condition I: P>ATC
$
TR
MC
ATC
D
AVC
TC
P>ATC==> Profit
P>AVC==> Stay Open
Q
Perfect Competition:
Condition II: AVC< P < ATC
$
MC
ATC
AVC
D
Where
does
P=MC?
Q
Perfect Competition:
Condition II: AVC< P < ATC
$
MC
ATC
AVC
D
Q
Perfect Competition:
Condition II: AVC< P < ATC
LOSS
MC
$
ATC
AVC
TC
D
TFC
TVC
P<ATC==> Loss
P>AVC==> Stay Open
Q
Perfect Competition:
Condition III: P<AVC
$
MC
ATC
AVC
Where
does
P=MC?
D
Q
Perfect Competition:
Condition III: P<AVC
$
MC
ATC
AVC
Where
does
P=MC?
D
Q
Perfect Competition:
Condition III: P<AVC
MC
$
ATC
AVC
TC
LOSS
if firm
produces
TFC
D
TVC
P<ATC==> Loss
P<AVC==> Better to close
Q
Two ways to figure
“I should shut down”
Continue to operate if….
TFC  LOSS
TFC  (TR  TC )
TFC  TC  TR
TFC  TFC  TVC  TR
TR  TVC
Road Map
Costs
Definition
Graphs
Tables
Tables
Remember when we did all those cost tables?
N
1
2
3
4
5
Q
4
10
14
17
19
MP
4
6
4
3
2
TVC
12
24
36
48
60
TC
27
39
51
63
75
AVC
ATC
3
6.75
2.4
3.9
2.571429 3.642857
2.823529 3.705882
3.157895 3.947368
MC
3
2
3
4
6
W=$12, TFC=$15
Now, in order to determine where the firm should operate,
need to know... P=$4
Where does P=MC?
A: Q=17
Profit = TR- TC = $4 * 17 - 63 = 68-63 = 5
Firm should (obviously) not shut down.
Tables
Condition I
N
1
2
3
4
5
Q
4
10
14
17
19
MP
4
6
4
3
2
TVC
12
24
36
48
60
TC
27
39
51
63
75
AVC
ATC
3
6.75
2.4
3.9
2.571429 3.642857
2.823529 3.705882
3.157895 3.947368
MC
3
2
3
4
6
W=$12, TFC=$15, P=$4
Note that (indeed, just as we claimed) profit is maximized at
P=MC.
TR
TC
Profit
Why is here better than here?
16
27
-11
40
56
68
76
39
51
63
75
1
5
5
1
Answer: normal
profit/opp cost
Perfect Competition:
PROFIT
Condition I: P>ATC
$
TR
MC
ATC
D
AVC
TC
P>ATC==> Profit
P>AVC==> Stay Open
Q
Suppose P = $3
N
1
2
3
4
5
Tables
Condition II
MP
4
6
4
3
2
Q
4
10
14
17
19
TVC
12
24
36
48
60
TC
27
39
51
63
75
AVC
ATC
3
6.75
2.4
3.9
2.571429 3.642857
2.823529 3.705882
3.157895 3.947368
MC
3
2
3
4
6
W=$12, TFC=$15, P = $3
P=MC at Q=14==> profit = 42 - 51 = -9 (loss of 9)
but stay open (9<15)
Profit is maximized at the largest Q where P=MC.
Compare here and
TR
TC
Profit
12
27
-15
here (P=MC at both)
30
42
51
57
39
51
63
75
-9
-9
-12
-18
Perfect Competition:
Condition II: AVC< P < ATC
LOSS
$
MC
ATC
TC
AVC
D
TR
P<ATC==> Loss
P>AVC==> Stay Open
Q
Suppose P = $2
N
1
2
3
4
5
Q
4
10
14
17
19
Tables
Condition III
MP
4
6
4
3
2
TVC
12
24
36
48
60
TC
27
39
51
63
75
AVC
ATC
3
6.75
2.4
3.9
2.571429 3.642857
2.823529 3.705882
3.157895 3.947368
MC
3
2
3
4
6
W=$12, TFC=$15, P = $2
P=MC at Q=10==> profit = 20 - 39 = -19 (loss of 19)
Now should close (19>15)
Note that
1. Loss at Q>0 where P=MC > TFC
2. TR<TVC
Perfect Competition:
LOSS
Condition III: P<AVC
$
MC
ATC
AVC
TC
D
TR
P<ATC==> Loss
P<AVC==> Better to close
Q
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Your Turn
N
1
2
3
4
5
Q
3
7
10
12
13
Wage = $24, TFC = $60,
P =$12
N
1
2
3
4
5
Q
5
15
30
40
45
Wage = $30, TFC=$60,
P=$3
What is best Q>0? Profit/loss at this Q? Should firm shut down?
Sketch the graph.
What if TFC = $110? What does this do to the best Q>0 and
the shutdown decision?