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Perfect
Competition
1
Review
1. Identify the 4 Market Structures
2. Identify the characteristics of perfect competition
3. Why is a perfectly competitive firm a “price
taker”?
4. Explain why perfectly competitive firms make
little profit
5. How do ALL firms determine what output to
produce?
6. Draw a perfectly competitive firm producing 10
units at a price of $10 making a profit of $30
7. Draw and label a perfectly competitive firm
making a loss.
8. On your graph, identify the shut down point
2
Side-by-side graph for perfectly
competitive industry and firm.
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
AVC
D
5000
Industry
Q
8
Q
Firm
(price taker)
3
Where is the profit maximization point? How do you know?
What output should be produced? What is TR? What is TC?
How much is the profit or loss? Where is the Shutdown Point?
Cost and Revenue
$25
MC
20
Profit
15
MR=P
ATC
AVC
10
Total Revenue Total Cost
0
1 2 3 4 5 6 7 8 9 10
4
Marginal
Cost and
Supply
5
Marginal Cost and Supply
Cost and Revenue
As price increases, the quantity
increases
$5
0
45
40
35
30
25
20
15
10
5
0
MC
ATC
MR5
AVC
MR4
MR3
MR2
MR1
1
2
3
4
5
6
7
9
Q
6
Marginal Cost and Supply
Cost and Revenue
When price increases, quantity increases
When price decrease, quantity decreases
$5
0
45
40
35
30
25
20
15
10
5
0
MC = Supply
ATC
MC above AVC is the
AVC
supply curve
1
2
3
4
5
6
7
9
Q
7
Marginal Cost and Supply
Cost and Revenue
What if variable costs increase (ex: tax)?
$5
0
45
40
35
30
25
20
15
10
5
0
MC2=Supply2
MC1=Supply1
AVC
AVC
When MC increases, SUPPLY decrease
1
2
3
4
5
6
7
9
Q
8
Marginal Cost and Supply
Cost and Revenue
What if variable costs decrease (ex: subsidy)?
$5
0
45
40
35
30
25
20
15
10
5
0
MC1=Supply1
MC2=Supply2
AVC
AVC
When MC decreases, SUPPLY increases
1
2
3
4
5
6
7
9
Q
9
Perfect Competition
in the Long-Run
You are a wheat farmer. You learn that
there is a more profit in making corn.
What do you do in the long run?
10
In the Long-run…
•Firms will enter if there is profit
•Firms will leave if there is loss
•So, ALL firms break even, they make
NO economic profit
(No Economic Profit=Normal Profit)
•In long run equilibrium a perfectly
competitive firm is EXTREMELY
efficient.
11
Side-by-side graph for perfectly completive
industry and firm in the LONG RUN
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
Q
8
Q
Firm
(price taker)
12
Firm in Long-Run Equilibrium
Price = MC = Minimum ATC
Firm making a normal profit
P
MC
ATC
$15
MR=D
There is no incentive
to enter or leave the
industry
TC = TR
8
Q
13
Going from Long-Run
to Short-Run
14
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000 6000 Q
Industry
8
Firm
Q
15
Firms enter to earn profit so supply
increases in the industry
Price decreases and quantity increases
P
S
P
MC
S1
ATC
$15
MR=D
$15
$10
D
5000 6000 Q
Industry
8
Firm
Q
16
Price falls for the firm because they are
price takers.
Price decreases and quantity decreases
P
S
P
MC
S1
ATC
$15
$15
MR=D
$10
$10
MR1=D1
D
5000 6000 Q
Industry
5 8
Firm
Q
17
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
MR1=D1
$10
D
5000 6000 Q
Industry
5
Firm
Q
18
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
$15
MC
ATC
MR=D
$15
D
4000 5000
Industry
Q
8
Firm
Q
19
Firms leave to avoid losses so supply
decreases in the industry
Price increases and quantity decreases
P
S1
S
P
MC
ATC
$20
$15
MR=D
$15
D
4000 5000
Industry
Q
8
Firm
Q
20
Price increase for the firm because they
are price takers.
Price increases and quantity increases
P
S1
S
P
$20
MC
$20
$15
$15
ATC
MR1=D1
MR=D
D
4000 5000
Industry
Q
89
Firm
Q
21
New Long Run Equilibrium at $20 Price
Zero Economic Profit
S1
P
P
$20
MC
$20
ATC
MR1=D1
D
4000
Industry
Q
9
Firm
Q
22
Going from Long-Run
to Long-Run
23
Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
MR1=D1
$15
MR=D
$15
D
5000
Industry
Q
8
Firm
Q
24
Demand Increases
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000
Industry
Q
8 9
Firm
Q
25
Firms enter to earn profit so supply
increases in the industry
Price Returns to $15
P
S S1
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000 7000 Q
Industry
8 9
Firm
Q
26
Back to Long-Run Equilibrium
The only thing that changed from long-run to
long-run is quantity in the industry
S1
P
P
MC
ATC
$15
MR=D
$15
D1
D
7000 Q
Industry
8
Firm
Q
27
Efficiency
28
PURE COMPETITION AND EFFICIENCY
In general, efficiency is the optimal use
of societies scarce resources
•Perfect Competition forces producers to use
limited resources to their fullest.
•Inefficient firms have higher costs and are
the first to leave the industry.
•Perfectly competitive industries are
extremely efficient
There are two kinds of efficiency:
1. Productive Efficiency
2. Allocative Efficiency
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Efficiency Revisited
Which points are productively efficient?
Which are allocatively efficient?
14
A
B
Bikes
12
G
10
Productive Efficient
combinations are A through D
(they are produced at the
lowest cost)
8
E
6
Allocative Efficient
combinations depend on
the wants of society
C
4
F
2
D
0
0
2
4
6
8
10
Computers
30
Productive Efficiency
The production of a good in a least
costly way. (Minimum amount of
resources are being used)
Graphically it is where…
Price = Minimum ATC
31
Short-Run
Price
MC
ATC
D=MR
Profit
P
Notice that the product is NOT being made
at the lowest possible cost
(ATC not at lowest point).
Q
Quantity
32
Short-Run
MC
Price
ATC
P
Loss
D=MR
Notice that the product is NOT being made at the
lowest possible cost (ATC not at lowest point).
Q
Quantity
33
Long-Run Equilibrium
MC
Price
ATC
D=MR
P
Notice that the product is being made at
the lowest possible cost (Minimum ATC)
Q
Quantity
34
Allocative Efficiency
Producers are allocating resources
to make the products most wanted
by society.
Graphically it is where…
Price = MC
Why? Price represents the benefit
people get from a product.
35
Long-Run Equilibrium
Price
MC
MR
P
Optimal amount
being produced
The marginal benefit to society
(as measured by the price) equals
the marginal cost.
Q
Quantity
36
What if the firm makes 15 units?
Price
MC
MR
The marginal benefit to
society is greater than the
marginal cost.
Not enough produced.
Society wants more
$5
$3
15 20
Quantity
Underallocation
of resources
37
What if the firm makes 22 units?
MC
Price
$7
MR
$5
The marginal benefit to
society is less than the
marginal cost.
Too much Produced.
Society wants less
20 22
Quantity
Overallocation of
resources
38
Long-Run Equilibrium
MC
Price
ATC
D=MR
P
P = Minimum ATC = MC
EXTREMELY EFFICIENT!!!!
Q
Quantity
39
RELATIONSHIP
ECONOMIC INTERPRETATION
MR = MC
The firm has chosen the output that
maximizes profits.
P > ATC
Firm is earning Economic Profits
P = ATC
Firm is earning NORMAL PROFIT
(Break-Even Point) (EP = 0)
P < ATC;
P > AVC
Loss Minimization
P = AVC
SHUTDOWN POINT (firm cannot
cover its AVC
P < AVC
Firm does not produce
40
PURE COMPETITION
P = MR
The firm’s DEMAND CURVE is infinitely ELASTIC
MR = MC
The firms maximizes profit.
P= ATC
Long Run (NORMAL PROFITS)
PRODUCTIVE EFFICIENCY
P = min ATC
Firm is forced to operate with maximum productive efficiency.
(Least-Cost Method Production)
ALLOCATIVE EFFICIENCY
P = MC
There is an optimal allocation of resources.
41