Download Chapter 11 Perfect Competition

Chapter 14 Perfect Competition
A. Terms
1. Market Structure – these are all the characteristics of the market that influence
behavior and activity in the market from buyers and sellers.
Determinants:
(a) number of buyers and sellers
(b) standard of product  homogenous or heterogeneous
(c) barriers to entry or exit
Note: these are the same characteristics we will look at to compare all types of markets
2. Perfect Competition Market Structure – a market is defined to be perfectly
competitive if it has:
(a) Many buyers and sellers – so each company or buyers is very small relative to the
market.
(b) homogenous goods
(c) No barriers to entry or exit – there are no large set up costs, competitive advantages
of incumbents, or regulations that inhibit entry or exit.
-we don’t assume malicious competition, just firms competing in profit max/costs
-we also note that there are not any true examples of perfect competition. Many markets
may exhibit many qualities and come close to mimicking it, but it is more or less a
reference point/ideal for comparison.
B. Firms in Perfect Competition
Recall: a market is a collection of buyers and sellers. So to get market we simply sum up
individual supply or demand of each firm.
1. Costs – Firms face costs that are similar to all the cost curves that we studied earlier.
So they face SR and LR cost curves as well as total and avg cost curves.
-We note that in perfect competition that each firm is similar in structure so we assume
same cost structure for each firm for simplicity.
2. Price-taker – a firm does not control price. It takes market price as a given and must
accept this market outcome as the price it will receive for its good. This goes back to the
idea that there are many sellers and if they did raise price they would lose all demand.
Graphically:
P
Market
P
S
Firm
Pmarket
Dfirm = MR
= Pmarket
D
1
Q
Q
Note: so we see from the above graphs that a firm demand curve is perfectly elastic. This
means that any change in price would result in a D = O.
3. Costs and Revenue/ Profit for Firms in PC
-we are still going to show both the total and marginal approaches to calculating profit,
but will note that the marginal method is going to be employed much more vigorously.
a. Total Approach – note that they face a similar TC, but the TR is just a straight-line up
from the origin since TR = P*Q.
TR TC
Graphically:
C, R or $
Profit Max  TRTC is the greatest
distance apart
Q
Q*
b. Marginal Approach – now we use MC = MR as before and use the specific graphs that
pertain to PC. We get the same results that we obtain from the total approach.
Graphically:
P
MC
Firm
Dfirm = MR
= Pmarket
Profit Max:
where
MC=MR
Q
Q*
4. Alternate way of finding profit in PC
a. Mathematically:
(1) Profit per unit = P – ATC
(2) Total Profit = Q (P – ATC)
So as long as we have P > ATC we are earning a profit. If we have P < ATC we are
earning losses and must move into the shutdown decision.
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MC
b. Graphically:
Profit / Unit
ATC
Dfirm = MR
= Pmarket
Profit
Cost / Unit
Profit Max:
where
MC=MR
Total Cost
Q*
Note: show what happens as we have P changing.
5. Re-interpreting the MC curve
Recall that a supply curve shows us all the P, Q combos that firms are willing to supply at
given their current cost structure and profit max assumption. If note that a firm always
goes back to their MC curve to find where to supply as we can say that a MC-curve is a
firm’s supply curve.
Note: It is the upward sloping portion and to get market we simply sum up all the SR
supply curves of all the firms to get them. A firm must at least be covering AVC to have
this be the case. If not, they are looking into shutting down.
Graphically:
MC
$
MR  let MR go up and
down to notice MC is the
supply curve.
Q
Q*
6. Markets in PC
a. SR - To get industry and firm supply in the SR we use the MC curve and note that it is
where a profit-maximizing firm will supply to at each point. To get the industry supply
we simply horizontally sum the individual firm’s MC curves and since they are all the
same we can note that Q=q*N where N is the number of firms in the industry.
Recall:
(1) That firms and K are fixed in the SR. Since it takes a while for market capital
structure to change we assume that no firms can enter in the SR.
(2) There is no guarantee of profit. It could be any of the three cases we have identified
before (+, - , or 0 profit).
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Graphically:
Firm
Market
Supply
MC
P
MR=P
Q
Q
q
q*N=Q
b. LR – in the LR firms are not fixed. So, if firms are earning profit in a market in the SR
we expect market entrants. So overall we expect:
(+) profit  new entrant  supply ↑  P ↓  profit drops until we have MC =
MR=ATC or no more economic profit.
Graphically:
Firm
Market
MC
S1
MR=P
S2
Q
Q
P
q1 q2
Q1
Q2
-So we see that in the LR as new firms enter we go to 0-economic profit where the MR
curve of the firm intersects the lowest point of the ATC and MC curve.
-‘0’ economic profit does not mean no accounting profit. It just means that there is no
more incentive (i.e. above normal returns than market) for firms to enter.
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