Perfect Competition

Competition

Perfect Competition
Firms Choices in Perfect Competition
The Firms Short-Run Decision
The Firms Supply Curve
The Industry Supply Curve
 Perfect Competition
Perfect competition occurs in a market where:
There are many firms, each selling an identical product
There are many buyers
Firms in the industry have no advantage over potential new
entrants
Firms and buyers are well informed about the prices of the
products of each firm in the industry
 Perfect Competition

In perfect competition, each firm is a price taker

Examples of firms in perfect competition:
Wheat farms
Fisheries
Paper pulpers and millers
Photo finishers
Sweater knitters
Firms Choices in Perfect
Competition
In a perfectly competitive market, a firm must
make four key decisions:
Whether to enter the industry
If enter, whether to stay in the industry or leave it
If stay, whether to produce or to temporarily shut down
If produce, how much to produce (and how to produce
it)
The Firms Short-Run Decision

All decisions turn on profit--which action makes

the maximum profit
Economic profit = total revenue minus total cost
[Remember, total cost includes normal profit, an
opportunity cost.]
Total revenue = Price x Quantity
Revenue in Perfect Competition

The revenue curves in perfect competition are:

Average revenue
Marginal revenue
Total revenue
Figure 11.1 shows the revenue curves of a firm in
perfect competition.
 Revenue in Perfect Competition

First, market
demand and
market supply
determine the
price that the firm
takes as given.
Revenue in Perfect Competition

The firm can sell

any quantity it
chooses at this
price.
Revenue in Perfect Competition

The firms demand

curve is perfectly
elastic.
Average revenue
(AR) = marginal
revenue (MR).
 Revenue in Perfect Competition
The firms total
revenue curve is
linear.
An increase in the
quantity sold brings a
proportional increase
in total revenue (TR).
The Firms Short-Run Decision

The firms short-run problem is to chose the

output that maximizes profit.
We can solve this problem by looking at
either:
total cost and total revenue, or
marginal cost and marginal revenue.
 The Firms Short-Run Decision

Fig. 11.2(a) shows the

firms profit
maximizing output by
using total cost and
total revenue.
The Firms Short-Run Decision
At low output rates,
the firm incurs an
economic loss.
The reason is that it
has some fixed
costs.
The Firms Short-Run Decision
At an output rate of
4 sweaters a day,
the firm breaks
even.
The Firms Short-Run Decision
At output rates
above 12 sweaters
a day, the firm
again incurs an
economic loss.
This time, the
reason is
diminishing
returns.
The Firms Short-Run Decision
At 12 sweaters a
day, the firm breaks
even.
Between 4 and 12
sweaters a day, the
firm makes an
economic profit.
The Firms Short-Run Decision
The maximum
profit occurs at 9
sweaters a day.
Here, total revenue
is $225, total cost is
$183, and
economic profit is
$42.
The Firms Short-Run Decision
Fig. 11.2(b) shows
the firms profit
maximizing output
by using the profit
curve.
The profit curve
reaches its
maximum at 9
sweaters a day.
 The Firms Short-Run Decision
Fig. 11.3 shows
profit maximizing
output by using
marginal analysis.
Marginal revenue
equals marginal
cost
 The Firms Short-Run Decision
If output is 8
sweaters a day, the
revenue from the
8th sweater, MR,
exceeds the cost of
the 8th sweater,
MC.
 The Firms Short-Run Decision
So profit can be
increased by
increasing output to
9 sweater a day.
 The Firms Short-Run Decision
If output is 10
sweaters a day, the
revenue from the
10th sweater, MR,
is less than the cost
of the 10th sweater,
MC.
 The Firms Short-Run Decision
So profit can be
increased by
decreasing output
to 9 sweater a day.
The Firms Short-Run Decision

Profit maximization does not guarantee a profit

When price equals marginal cost, average total
cost, ATC, can be greater than, equal to, or less
than price.
Profit maximization can mean loss minimization.
The Firms Short-Run Decision

Fig. 11.4 shows the three possible outcomes:

economic profit
break even
economic loss
 The Firms Short-Run Decision
Here, the firm makes
an economic profit.
The price is $25 and
the profit-maximizing
quantity is 9.
ATC is less than AR.
 The Firms Short-Run Decision
Here, the firm breaks
even.
The price is $20 and
the profit-maximizing
quantity is 8.
ATC equals AR.
 The Firms Short-Run Decision
Here, the firm incurs
an economic loss.
The price is $17 and
the profit-maximizing
quantity is 7.
ATC exceeds AR.
The Firms Short-Run Decision

The shutdown point is the point at which the firm's

maximized profit is the same regardless of whether
the firm produces or temporarily shuts down.
The shutdown point is the point of minimum average
variable cost
The Firms Short-Run Decision

If price equals minimum AVC, the profit is the same

from producing as from shutting down temporarily
and paying the fixed costs.
Either way, the firm incurs a loss equal to total fixed
cost.
If the firm produced with AVC greater than price, its
loss would exceed total fixed cost.
The Firms Short-Run Decision

Fig. 11.5(a) shows

the shutdown
decision and the
shutdown point.
The Firms Supply Curve
A perfectly competitive firm's supply curve shows
how the firm's profit maximizing output varies as
the market price varies.
A perfectly competitive firm's supply curve is the
firm's marginal cost curve above the point of
minimum average variable cost.
 The Firms Supply Curve
Fig. 11.5 shows
the firms supply
curve.
We begin with the
firms cost curves
in 11.5(a).
 The Firms Supply Curve
For prices above
minimum AVC, a
change in price
brings a change in
the quantity
supplied along the
MC curve.
 The Firms Supply Curve
At minimum AVC,
the firm is
indifferent
between supplying
7 and supplying
zero.
Both are points on
the firms supply
curve.
 The Firms Supply Curve
But nothing in
between 7 and zero
is on the supply
curve.
The firm will never
supply 1,,6
sweaters a day.
 The Firms Supply Curve
At prices below
minimum AVC, the
quantity supplied is
zero.
Lets look at the
supply curve.
 The Firms Supply Curve
At prices below
minimum AVC, the
quantity supplied is
zero along the price
axis.
Then there is a jump
from zero to the
shutdown point.
 The Firms Supply Curve
And at prices above
minimum AVC, the
quantity supplied is
traced by the MC
curve.
The Industry Supply Curve
The short-run industry supply curve
The horizontal sum of the firms supply curves
 The Industry Supply Curve
Figure 11.6 shows
the industry supply
curve.
It is like the firms
curve except it has
no break at the
shutdown price.
THE END