Download Perfect Competition

Perfect Competition
I.
II.
III.
Assumptions
Market vs. Firm demand
Short Run Equilibrium
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1.
2.
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The Total Approach: Numerical Ex.
The Marginal Approach.
a.
b.
c.
d.
e.
Profits
Losses
Shut-down
Short-run Supply Curve
Calc. Approach d∏/dQ = 0
Contents
• IV. Long-run equilibrium.
– 1.
– 2.
Super-normal profits  Entry
Losses  Exit.
• V. Industry SS Curve: Horizontal
Summation of firm SS curves.
Assumptions behind Perfect
Competition
1. Product Homogeneity
All firms sell an identical product. There is no way the buyer can
differentiate among different firms' products.
2. Large number of buyers and sellers.
No individual firm or buyer, no matter how large their sales or
purchases, can influence market quantity.
3. Free entry and exit of firms.
No barriers either cost or legal barriers to entry  Promotes
competition.
4. Perfect knowledge
Sellers and buyers have complete knowledge of the market.
5. Factor Mobility:
Factors of production are free to move from one firm to another.
Market and Firm Demand:
• Although market demand may slope
downwards, firm demand is always
perfectly elastic.
•
Given the large number of sellers and
perfect knowledge if a firm tries to raise its
price above the market price, it will lose all
its business.
Market and Firm Demand
• Graphs
SR
EQUILIBRIUM
– TOTAL
APPROACH
Short-run equilibrium
Short-run equilibrium
1. The Total Approach:
Maximize ∏ = TR - TC
Profits (∏)
Total Revenue (TR) = Price (P) * Quantity (Q)
Numerical example: See handout
Note:(1) ∏ = ∏ max when the gap between TR and TC is
largest.
(2)
∏ = ∏ max when MR = MC.
(TR from each additional unit sold)
(TR per unit sold)
Note:
P = AR = MR under Perfect Competition.
Short-run equilibrium
•
The Marginal Approach – Graphs
(a) Firm makes a Profit
(b) Firm makes a Loss
Short-run equilibrium
• Marginal Approach
– Firm makes a profit
– Firm makes a loss
– Firm breaks even
Short-run equilibrium
Shut-down Decision of the Firm
Idea max ∏ or min losses.
Px < AVC min
 Shut down
because you minimize your losses by only paying fiscal
costsSince you can't cover any variable costs producing
output only increases losses
Esc: If you cannot even cover the paychecks of employees
it is better to shut-down and pay only the rent on land
and machinery rather than also have to pay employees
out of your own pocket.
SR SHUT DOWN DECISION &
SUPPLY CURVE OF THE FITM
Short-run equilibrium
• The Marginal Approach – Calculus
• ∏ (Q) = TR (Q) –TC(Q) =0
d
dTR
dTC


 0
dQ
dQ
dQ
d 2
0
dQ 2
Short-run equilibrium
• The Marginal Approach – Calculus
Example
Long-run equilibrium
• Super-normal profits exist.
•  Firms enter the industry to reap those
profits  Industry SS shifts S.E.
•  Market equilibrium price falls.
•  Profits are completed away (by higher
input costs)
• Long-run equilibrium is achieved.
• Price falls till P = LMC = AC min
Long-run equilibrium
• Firms are making losses
•  Some firms exit the industry to avoid
losses greater than Total Fixed Costs.
•  Industry SS shifts N.W.
•  Market equilibrium price rises
• till P = LMC = AC min
Shifts in Cost Curves
SR: (Better tech. or more of a fiscal input).
Change in FC shifts ATC but not AVC
Change in VC shifts AVC and ATC.
LR: All costs are variable.