Download Perfect Competition

CH12 :Perfect
Competition
Asst. Prof. Dr. Serdar AYAN
Types of Markets
 Pure
Competition or Perfect Competition
 Monopoly
 Duopoly
 Oligopoly
 Monopolistic Competition
Perfect Competition
Assumptions
of Perfect Competition
 Many
independent firms
 Each seller is small relative to the whole market
 Homogeneous (identical) product
 Easy entry and exit
 Perfect Information
Price Taking
The perfectly competitive firm is said to be a
price-taker, because it takes the market
price as given and has no control over the
price. Why?...
If the firm tried to charge a higher price, it
would lose all its business. Customers
could go elsewhere to buy the same product
for less.
Since the firm is very small, it can sell as
much as it wants at the market price. So
there’s no reason to charge a lower price.
The demand curve for the product of the
perfectly competitive firm shows how much
can be sold at specific prices. Let’s see what
it would look like...
The firm can sell as little or as much as it
wants at the market price. Suppose, for
example, the market price is 5TL.
The firm can sell 10 units for 5TL.
price
5TL
10
quantity
The firm can sell 20 units for 5TL.
price
5TL
20
quantity
The firm can sell 30 units for 5TL.
price
5TL
30
quantity
The firm can sell 40 units for 5TL.
price
5TL
40
quantity
The firm can sell 50 units for 5TL.
price
5TL
50 quantity
So all these points are on the demand
curve for the firm’s product.
price
5TL
quantity
Connecting these points, we have the
demand curve for the firm’s product.
price
5TL
demand
quantity
The demand curve for the perfectly
competitive firm’s product is a
horizontal line at the market price.
price
market price
demand
quantity
Recall: Total Revenue
Total Revenue = Price x Quantity
TR = P x Q
Recall: Marginal Revenue (MR)
Marginal Revenue is the additional revenue
earned from selling one additional unit of
output.
MR = DTR / DQ
comment
For ease of writing, instead of writing the
“perfectly competitive” firm we will
frequently write the “p.c.” firm.
The MR Curve
for the p.c. Firm
For the p.c. firm, MR is equal to the market price.
So MR is a horizontal line at the level of that
price.
The demand curve for the p.c. firm is also a
horizontal line at the level of the market price.
So, for the p.c. firm, the demand curve and the
MR curve are the same horizontal line.
The demand curve (D) and the MR
curve for the perfectly competitive
firm’s product.
price
market price
D = MR
quantity
Optimal Output Level
Recall:
To maximize profit, the firm will produce at
the output level where MR = MC.
So the firm will produce where the MR and
MC curves intersect.
Draw your axes; label them quantity and TL.
TL
Quantity
Draw your ATC, AVC, and MC curves. (Make sure
MC intersects ATC and AVC at the minimum.)
TL
ATC
AVC
MC
Quantity
Draw the D = MR curve horizontal
at the market price.
D = MR
TL
ATC
AVC
MC
Quantity
If the market price is P1 ,
the quantity produced will be Q1.
D = MR
TL
P1
ATC
AVC
MC
Q1
Quantity
If the market price is P2 ,
the quantity produced will be Q2.
TL
ATC
D = MR
P2
AVC
MC
Q2
Quantity
If the market price is P3 ,
the quantity produced will be Q3.
TL
ATC
P3
AVC
D = MR
MC
Q3
Quantity
If the market price is P4 ,
the quantity produced will be Q4.
TL
ATC
P4
AVC
D = MR
MC
Q4
Quantity
If the market price is P5 ,
the quantity produced will be Q5.
TL
ATC
AVC
D = MR
P5
MC
Q5
Quantity
Shutdown Point
Price P5 was the minimum of the AVC curve
(the shutdown point). If the price fell any
lower than P5 the firm would produce no
output.
The p.c. firm’s short run supply curve
The firm’s supply curve shows the quantity the firm
will produce at each price.
The P, Q values we have shown, therefore, are
points on the firm’s supply curve.
But those points are all on the firm’s MC curve.
So, the firm’s supply curve is the part of the MC
curve that is above the minimum of the AVC
curve.
The p.c. firm’s short run supply curve
Supply
TL
ATC
AVC
MC
Quantity
The market short run supply curve
To determine the total amount that all the
firms will produce at each price, we simply
add up the amounts that each of the firms
will produce at that price.
Graphing Profit
A little trick for graphing a firm’s profit
Recall for a rectangle: Area = length . width
length
Area
width
We also know TR = P . Q.
So, if we can find a rectangle
whose length is P and whose
width is Q, then its area must
be total revenue.
P
TR
Q
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
ATC
Now, if we can find a rectangle
whose length is ATC and whose
width is Q, then its area is TC.
TC
Q
Then to determine profit,
we just subtract the TC area from the TR area.
Graphing Profit:
The six steps
Step 1 a. Draw your axes and label them Q and
TL. ( Label the origin 0.)
TL
0
Quantity
Step 1b. Draw the firm’s ATC curve. (If the price is below the
minimum of ATC, you will also need to draw the AVC curve.)
TL
MC
ATC
P
0
Quantity
Step 1 c. Draw the MC curve and D=MR curve. (For a
positive profit, D must be at least partly above ATC.)
TL
MC
ATC
P
D = MR
0
Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC
TL
P
0
ATC
D = MR
Q*
Quantity
Step 3: Find your TR = PQ rectangle.
MC
TL
P
0
ATC
D = MR
Q*
Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
MC
TL
P
ATC
D = MR
ATC
0
Q*
Quantity
Step 5: Find your TC = ATC . Q rectangle.
MC
TL
P
ATC
D = MR
Q*
Quantity
Step 6: Find profit p = TR - TC.
MC
TL
P
ATC
D = MR
profit
Q*
Quantity
You follow the same steps to
draw a firm that is making a loss
or breaking even (zero profits).
Let’s do a firm with a loss.
Step 1: Draw & label the curves & axes. For a loss, put D
above the minimum of AVC & below the minimum of ATC.
TL
MC
ATC
AVC
P
D = MR
0
Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC
TL
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 3: Find your TR = PQ rectangle.
TL
MC
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 4: Determine ATC at the profit-maximizing
(or loss-minimizing) output level.
TL
MC
ATC
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 5: Find your TC = ATC . Q rectangle.
TL
MC
ATC
ATC
AVC
P
D = MR
0
Q*
Quantity
Step 6: Find profit (or loss) p = TR - TC.
MC
TL
ATC
AVC
loss
P
D = MR
0
Q*
Quantity
A firm that is breaking even
(zero profits)
Step 1: Draw & label the curves & axes. To break even,
make D tangent to the minimum of ATC.
TL
P
0
MC
ATC
D = MR
Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC
TL
D = MR
P
0
ATC
Q*
Quantity
Step 3: Find your TR = PQ rectangle.
MC
TL
D = MR
P
0
ATC
Q*
Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
MC
TL
D = MR
ATC = P
0
ATC
Q*
Quantity
Step 5: Find your TC = ATC . Q rectangle.
MC
TL
D = MR
ATC = P
0
ATC
Q*
Quantity
Step 6: Find profit p = TR - TC.
MC
TL
D = MR
ATC = P
0
ATC
Q*
Quantity