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Perfect Competition
Market Structure – A classification system for the key traits of a
market, including
• the number of firms,
• the similarity of the products they sell, and
• the ease of entry and exit
Perfect Competition
many small firms (no firm, not even the largest, can impact
market price)
homogeneous (identical) product (goods cannot be
distinguished from one another; corn, wheat etc…)
very easy entry and exit
Firms operating in perfect competition are price takers ( sellers
with no control over the price of the product they sell)
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Revenue
Total Revenue – price times quantity
TR  P  Q
Average Revenue – total revenue
divided by the quantity
TR
AR 
Q
Marginal revenue – the change in total
revenue from an additional unit sold
MR 
TR TR1  TR0

Q
Q1  Q0
In Perfect Competition both AR and MR are equal to Price
Firms don’t have to discount to sell more output
Firms may sell large amounts of output or little
output at the market price
A firm’s participation in the market will not impact price
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Revenue
One Firm’s Demand Curve
TR  PQ
Q
P
TR
MR
0
$10
$0
----
1
$10
$10
$10
2
$10
$20
$10
3
$10
$30
$10
4
$10
$40
$10
$20
5
$10
$50
$10
$15
6
$10
$60
$10
7
$10
$70
$10
8
$10
$80
$10
9
$10
$90
$10
TR TR1  TR0
MR 

Q
Q1  Q0
$25
Perfectly Elastic Demand
$10
P = MR = D
$5
$0
0
1
2
3
4
5
6
7
8
9 10
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Short-run Decisions
Business Objective: Maximize Profit
Total Profit = Total Revenue – Total Cost
Achieve Profit Maximization
Marginal Revenue = Marginal Cost
MR  MC
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Short-run Decisions
Q
P
TR
MR
TFC
TVC
TC
MC
AFC
AVC
ATC
Profit
0
$10
$0
----
$10
$0
$10
----
$10
$0
$10.00
-$10
1
$10
$10
$10
$10
$4
$14
$4
$10
$4.00
$14.00
-$4
2
$10
$20
$10
$10
$7
$17
$3
$5
$3.50
$8.50
$3
3
$10
$30
$10
$10
$11
$21
$4
$3.33 $3.67
$7.00
$9
4
$10
$40
$10
$10
$18
$28
$7
$2.50 $4.50
$7.00
$12
5
$10
$50
$10
$10
$28
$38
$10
$2.00 $5.60
$7.60
$12
6
$10
$60
$10
$10
$47
$57
$19
$1.67 $7.83
$9.50
$3
7
$10
$70
$10
$10
$74
$84
$27
$1.43 $10.57
$12.00
-$14
8
$10
$80
$10
$10
$112
$122
$38
$1.25 $14.00
$15.25
-$42
9
$10
$90
$10
$10
$162
$172
$50
$1.11 $18.00
$19.11
-$82
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Short-run Decisions
Single Firm
$25
MC
Profit
Maximization
MR = MC
$20
ATC
AVC
$15
P = MR = D
$10
$7.60
$5
$0
0
1
2
3
4
5
6
7
8
9
10
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Short-run Decisions
Rules to Maximize Profit
If MR > MC – increase production
If MR < MC – decrease production
If MR = MC – profit-maximizing level of output
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Short-run Decisions
Single Firm
Total Revenue $10 • 100 = $1,000
TVC = $7 • 100 = $700
$
MC
ATC
TFC = $1 • 100 = $100
AVC
$10
D=MR
Profit = $200
$8
$7
TFC = $100
TR = $1,000
TVC = $700
100
Total Cost
$8 • 100 = $800
Economic Profit
$200
Q
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Short-run Decisions
Single Firm
Total Revenue
$
MC
ATC
TFC = $2 • 90 = $180
Total Cost
$7 • 90 = $630
AVC
Economic Loss
$7
$6
$5
$6 • 90 = $540
TVC = $5 • 90 = $450
TFC=$180
Loss=90
TR = $540
$90
D=MR
TVC = $450
90
Q
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Short-run Decisions
Single Firm
$
MC
AVC
P0
D0 (Economic Profit)
Economic
Profit
P1
P2
P3
ATC
D1 (Economic Profit equal zero)
AFC
Lost
AVC
D2 (Economic Loss – will produce)
Recovering some AFC
D3 (Economic Loss – shut down point)
P4
D4 (Economic Loss – will shut down)
Q
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Short-run Decisions
Marginal Cost curve determines the quantity a
firm is willing to supply at any price given:
– TR > TVC or
– P > AVC
• A firm’s short-run supply curve is the portion
of the marginal-cost curve that lies above
average variable cost
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Short-run Review
Fixed cost
– Has already been committed
– Cannot be recovered
– Ignore them when making decisions
Short run: Final Review
̶ number of firms is fixed
̶ each firm supplies quantity where P = MC
̶ Marginal Cost is supply curve when Price > AVC
̶ Market supply – add up quantity supplied by each firm
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Long-run Decisions
Long Run:
All inputs are variable (no fixed cost)
Firms are free to change scale
Firms may enter the market
Firms may exit the market
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Cost Review
Parish Shoe Co.
Revenue
$300,000
Cost
$250,000
Profit
Principal
Super
Teacher
$50,000
Explicit Cost – Payment to non owners for resources
Accounting Profit or Loss
$50,000
$30,000
$100,000
Implicit Cost – Opportunity cost
- $50,000
$20,000
$0
Economic Profit or Loss
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Long-run Equilibrium
A
Principal
Teacher
B
C
Teacher
Superintendent
Teacher
The Market
$15
$15
$15
$15
$10
$10
$10
$10
$5
$5
$5
$5
$0
$0
0 1 2 3 4 5 6 7 8 9
$0
0 1 2 3 4 5 6 7 8 9
$0
0 1 2 3 4 5 6 7 8 9
0 1 2 3 4 5 6 7 8 9
Suppose the only difference in all the above cost curves is the implicit cost in production. All three
producers are equal in production efficiencies and acquire resource inputs at the same price.
• Which chart illustrates the superintendent?
C
• Which chart illustrates the principal?
A
• Which chart illustrates the teacher?
B
The superintendent should exit the industry and return to education (higher opportunity cost)
Now suppose the only difference in all the above cost curves is the explicit cost in production.
All three producers are teachers but are unequal in production efficiencies or acquire resource
inputs at different prices.
“C” exits as the result of being less efficient relative to other competitors in the industry
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Long-run Equilibrium
Average Firm
Market
P
$
MC
S0
LRAC
S1
P0
D0 (Economic Profit)
P1
D1 (Normal Profit)
P2
D2 (Economic Loss)
S2
D0
Q
Q
Long Run Economic Profit – When firms make more than a normal profit, firms enter the
industry, as supply increases, a downward pressure is put on prices
Long Run Economic Loss – When firms make less than a normal profit, firms leave the
industry, as supply decreases, an upward pressure is put on prices
Long Run Equilibrium – At the market price that enables firms to make a normal profit
Normal Profit – The minimum profit necessary to keep a firm in operation
Long Run Perfectly Competitive Equilibrium – (P = MR = SRMC = SRATC = LRAC)
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Long-run Equilibrium
Long run with easy entry and exit
When price > average cost
– firms make economic profit
– new firms enter the market
When price < average cost
– firms make economic loss
– some firms exit the market
The process of entry and exit ends when
– firms still in market earn zero economic profit or normal profit
– Price is equal to average total cost
• where total cost includes all opportunity costs
• accounting profit is positive
– Efficient scale: Price = MC = minimum ATC
– Consumers purchase output at minimum ATC in the long run
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