Download Perfect Competition

Perfect Competition
I.
Assumptions:
1.
Product homogeneity.
2.
Large number of buyers and sellers.
3.
Free entry and exit of firms.
4.
Perfect knowledge.
5.
Factor mobility.
II.
Market vs. Firm demand
III.
Short Run Equilibrium
1.
The Total Approach: Numerical Ex.
2.
The Marginal Approach.
a.
Profits
b.
Losses
c.
Shut-down
d.
Short-run Supply Curve
e.
Calc. Approach d∏/dQ = 0
IV.
Long-run equilibrium.
1.
Super-normal profits  Entry
2.
Losses  Exit.
V.
Industry SS Curve: Horizontal Summation of firm SS curves.
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Perfect Competition
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.
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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.
Review:
1.
What are F.C.?
2.
How do you get TVC from these figures?
3.
How do you calculate MC?
4.
Why is price fixed at $25?
MC 
TC 2000  800 1200


 12
Q
100  0
100
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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.
MR 
TR
Q
(TR from each additional unit sold)
AR 
TR
Q
(TR per unit sold)
Note:
P = AR = MR
under Perfect Competition.
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2.
(A)
The Marginal Approach.
a.
Profit
MR = P > MC
b.
Loss
MR = P < MC
c.
Normal Profits
MR = P = MC
d.
Shut-down
P < AVC min.
(minimizes firm's losses)
e.
Short-run Supply Curve
Profit:
TR = OPx x Qxfirm
TC = OACYQxfirm
∏ = TR - TC = shaded area
Qxf determined by MR = MC and MC must be rising.
MC < MR ≥ ∏ by Q
MC > MR ≥ ∏ by Q
∏ (Q) = TR (Q) -TCCQ)
d dTR dTC
=0


dQ dQ
dQ
d 2
<0
dQ 2
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(b)
Loss:
TC = OAXY
TR = OPxYQf
∏ = TR - TC
= -(PxAXY)
MR = MC ≥
o xf is produced.
(c) Break-even
TR  OP x XQ xf
TC  OP x XQ xf
∏=0
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(d) Shut-down.
Idea max ∏ or min losses.
Px < AVC min
 Shut down
because you minimize your losses by
only paying fiscal costs
Since 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.
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(e) Short-run Supply Curve
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Long-run equilibrium:
1.
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
2.
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 shiftws AVC and ATC.
LR:
All costs are variable.