Perfect Competition

To determine structure of any particular market, we begin by asking How many buyers and sellers are there in the market? Is each seller offering a standardized product, more or less
indistinguishable from that offered by other sellers
firms?

Or are there significant differences between the products of different

Are there any barriers to entry or exit, or can outsiders easily enter
and leave this market?

Answers to these questions help us to classify a market into one of four basic types Perfect competition Monopoly Monopolistic Oligopoly 1

PERFECT COMPETITION
According to Prof. Leftwitch, Perfect competition is a market in which there are many firms selling identical product with no firms large enough relative to the entire market to be able to influence market price

ASSUMPTION OF PERFECT COMPETITION

Large

numbers of buyers and sellers Homogeneous product Free entry and exit of the firm Perfect knowledge Perfect mobility Price should be same
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PRICE DETERMINATION UNDER PERFECT COMPETITION

Industry Price per Demand Supply unit (units) (units) (Rs) 2 4 6 8 10 100 80 60 40 20 20 40 60 80 100

Firm Price per Quantity Total Average unit sold revenue Revenue (Rs) (units) (Rs) (Rs) 6 6 6 6 6 20 21 22 23 24 120 126 132 138 144 6 6 6 6 6 Marginal Revenue (Rs) 6 6 6 6 6

PRICE DETERMINATION contd

1. The intersection of the market supply and the market demand curve equilibrium Price Industry S Price 3. The typical firm can sell all it wants at the market price Firm

Rs 60 D

Rs 60

Demand Curve Facing the Firm

Output 2. determine the equilibrium market price

Output 4. so it faces a horizontal demand curve

PROFIT MAXIMIZATION IN PERFECT COMPETITION

In perfectly competitive the firm must take the price given by the industry. In maximizing profit, the firm decide how much output can be produced at that price. For deciding profit maximizing output we will discuss two time periods: Short run period Long run period
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SHORT RUN PERIOD

The

firms objective is to produce the level of output that will maximize profit or will be in equilibrium. Economic profit = total revenue minus total economic cost. Total revenue = price x quantity sold. Total cost = total fixed cost + total variable cost We will discuss two approaches help in determining level of output in short run:
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THE TOTAL REVENUE AND TOTAL COST APPROACH

To maximize profit, a producer finds the largest gap between total revenue and total cost.
Total revenue Short run total (Rs) cost TR 0.00 35.00 70.00 105.00 140.00 175.00 210.00 245.00 280.00 315.00 350.00 STC 40 68 88 104 118 130 147 169 199 239 293 Profit

Output

SUPER NORMAL PROFIT = T.R > T.C NORMAL PROFIT = T.R = T.C LOSS = T.R < T.C

Q 0 1 2 3 4 5 6 7 8 9 10

P -40 -33 -18 1 22 45 63 76 81 76 57

Profit Determination Using Total Cost and Revenue Curves

TC Loss $385 350 315 Maximum profit =Rs81 280 245 210 Rs130 175 140 105 Profit =Rs45 70 Loss 35 0 TR Profit

Total cost, revenue

1 2 3 4 5 6 7 8 9

Quantity

MARGINAL REVENUE AND MARGINAL COST APPROACH

The other way to decide how much output to produce involves the marginal approach. Marginal APPROACH M.R > M.C and M.C is rising, the firm will increase its output M.R < M.C and M.C is rising, the firm will decrease its output M.R = M.C and M.C is rising, the firm has reached its equilibrium output

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TABULAR EXPLANATION
Output Total revenue Marginal revenue = price (Rs) T.R 0 25 50 75 100 125 150 175 200 225 250 P 25 25 25 25 25 25 25 25 25 25 25 Short Total cost S.T.C 36 44 48 51 56 63 72 84 101 126 166 Short run Profit marginal cost SMC 8 4 3 5 7 9 12 17 25 40 P -36 -19 2 24 44 62 78 91 99 99 84

Q 0 1 2 3 4 5 6 7 8 9 10

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MARGINAL COST, MARGINAL REVENUE, AND PRICE GRAPH

P
Marginal Cost
MC > P, decrease output to increase total profit

MC = P Rs25
MC < P, increase output to increase total profit

AR = MR

MC = P at 9 units, total profit is maximized

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MEASURING PROFIT OR LOSS IN SHORT RUN

A firm in short run equilibrium may face these three situations : Firms earn a super normal profit whenever average revenue > average cost Firms earn a normal profit whenever average revenue = average cost Firms suffer a loss whenever average revenue < average cost
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FIRMS EARN SUPER NORMAL PROFIT

P
MC
MC = MR

Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects AC Since AR>AC at the profit maximizing quantity, this firm is earning profits

AC AVC
AR = MR

P AC

Profits

AC at Qprofitmx a

Qprofitmx a

FIRMS WITH ZERO PROFIT OR LOSSES

Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects AC Since AR=AC at the profit maximizing quantity, this firm is earning zero profit or loss

P
MC AC
MC = MR

P =AC

AVC
AR = MR AC at Qprofitmx a

Qprofitmx a

Q
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FIRMS WITH LOSSES

P
MC
AC at Qprofitmx a

Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects AC Since AR<AC at the profit maximizing quantity, this firm is earning losses

ATC AVC

AC P

Losses

AR = MR MC = MR

Qprofitmx a

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Determining Profits Graphically: The Shutdown Decision

The shutdown point is the point below which the firm will be better off if it shuts down than it will if it stays in business If P>min of AVC, then the firm will still produce, but earn a loss If P<min of AVC, the firm will shut down If a firm shuts down, it still has to pay its fixed costs

P
MC AC

AVC PShut
dw on

AR = MR

Qprofitmx a

Q
14-17

LONG RUN PERIOD

Long period refers to that period in which the producers get sufficient time to adjust their supplies according to the changing conditions of demand. In the long run all firms in equilibrium will be earning only normal profit. Two condition : New firms enters in industry Existing firms leave the industry
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NEW FIRM ENTER IN INDUSTRY (Attraction to higher price)

firm PRICE SMC Po P1 A B AR=MR Po P1 S Q1 Qo OUTPUT D S Qo Q1 OUTPUT SAC PRICE D

industry
S S

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EXISTING FIRM LEAVE INDUSTRY (induced by lower price price)

firm PRICE LOSSES SMC SAC SVC PRICE D

industry
S S

P2

P1 Po

B A

AR=MR AR=MR

P1 Po D S Qo Q1 OUTPUT

S Q1 Qo OUTPUT

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SUPPLY CURVE OF A FIRM & INDUSTRY

Supply curve indicates various quantities of the product that the producers are ready to produce and sell at different prices. Its divided in to two parts : Short run supply curve Long run supply curve

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SHORT RUN SUPPLY CURVE OF A FIRM

P
REVENUE / COST Supply curve

MC AC
E1

AVC
AR1=MR1 AR=MR

P1

P P
E

Q Q1
OUTPUT

Q 22

SHORT RUN SUPPLY CURVE OF A INDUSTRY

firm PRICE MC =S PRICE
E1

industry
S

P1 P E

E1

AR=MR AR=MR

P1 Po E

S Q Q1 OUTPUT Q Q1 OUTPUT

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LONG RUN SUPPLY CURVE OF A FIRM

LMC
SUPPLY CURVE

LAC
REVENUE / COST P E AR = MR

Q 0UTPUT

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DECREASING COST INDUSTRY AND SUPPLY CURVE

REVENUE / COST

firm SMC SAC LAC E D1 D Po S P1 A

industry
S S1 B S1 D D1 LS

Po
E1

SAC1

P1 SMC1 LAC1

Qo

Q1

Qo

Q1

OUTPUT

OUTPUT

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INCREASING COST INDUSTRY AND SUPPLY CURVE

REVENUE / COST

firm SMC1 SAC1 LAC1 E D P1 P SMC LAC S Q Q1 Q A S D1

industry
S1 LS

P1
E1

SAC

A
B

D1 D Q1

OUTPUT

OUTPUT

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