Perfect competition
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Transcript of Perfect competition
E.Sunil Kumar, MBA, NET, Ph.DAsso. Prof,Dept of MBA,Global Institute for Management
1. PERFECT COMPETITION: A MODEL
Learning Objectives1. Explain what economists mean by
perfect competition.2. Identify the basic assumptions of
the model of perfect competition and explain why they imply price taking behavior.
• Perfect competition is a model of the market based on the assumption that a large number of firms produce identical goods consumed by a large number of buyers.
Market structure can range from perfect competition and one end of the continuum to
monopoly at the other.
Market structure can range from perfect competition and one end of the continuum to
monopoly at the other.
1.1 Assumptions of the Model
• Price takers are individuals or firms who must take the market price as given.
• Identical goods• A large number of buyers and sellers• Ease of entry and exit• Complete information
1.2 Perfect Competition and the Real World
• The perfectly competitive model has strong assumptions.
• When we use the model we assume market forces determine prices.
• We can understand most markets by applying the supply and demand model.
• With this framework we can see how competition affect firms, consumer, and markets.
2. OUTPUT DETERMINATION IN THE SHORT RUN
Learning Objectives1. Show graphically how an individual firm in a perfectly
competitive market can use total revenue and total cost curves or marginal revenue and marginal cost curves to determine the level of output that will maximize its economic profit.
2. Explain when a firm will shut down in the short run and when it will operate even if it is incurring economic losses.
3. Derive the firm’s supply curve from the firm’s marginal cost curve and the industry supply curve from the supply curves of individual firms.
2.1 Price and Revenue
S
D
• Total revenue is a firm’s output multiplied by the price at which it sells that output.
EQUATION 2.1 QPTR
TR = $0.40*10 = $4TR = $0.40*10 = $4
Total Revenue, Marginal Revenue, and Average Revenue
Slope=0.4
Slope=0.2
TR, P=$0.60TR, P=$0.60
TR, P=$0.40TR, P=$0.40
TR, P=$0.20TR, P=$0.20
0.60 = MR = AR = P
0.40 = MR = AR = P
0.20 = MR = AR = P
Slope=0.6
Price, Marginal Revenue, and Average Revenue
• Marginal revenue is the increase in total revenue from a one-unit increase in quantity.
• Average revenue is total revenue divided by quantity.
EQUATION 2.1 PQ
QP
Q
TRAR
• Marginal revenue, price, and demand for the perfectly competitive firm
Price, Marginal Revenue, and Average Revenue
A perfectly competitive firm faces a horizontal demand
curve.
A perfectly competitive firm faces a horizontal demand
curve.
2.2 Economic Profit in the Short Run
1,50
0 6,70
0$9
38
1,742
2,680
Economic profit, which equals total revenue minus total costs, is
maximized at an output of 6,700 pounds of radishes per month
Economic profit, which equals total revenue minus total costs, is
maximized at an output of 6,700 pounds of radishes per month
Total CostTotal Cost
Total RevenueTotal Revenue
The slope of a line drawn tangent to the total cost curve at 6,700 pounds is
equal to 0.4, which is also equal to the slope of the total revenue curve. The
slope of the total cost curve is marginal cost; the slope of the total
revenue curve is marginal revenue.
The slope of a line drawn tangent to the total cost curve at 6,700 pounds is
equal to 0.4, which is also equal to the slope of the total revenue curve. The
slope of the total cost curve is marginal cost; the slope of the total
revenue curve is marginal revenue.
2.3 Applying the Marginal Decision Rule
• Economic profit per unit is the difference between price and average total cost.
Profit = $938Profit = $938
$0
.14
6,7
00
0.26
MC
MR
ATC
Producing to maximize economic profit.
Producing to maximize economic profit.
2.4 Economic Losses in the Short run
• Economic loss is the amount by which a firm’s total cost exceeds its total revenue.
Total loss = $222.20Total loss = $222.20
4,44
4
0.23
.018
0.14
MR1
MR2
ATC
MC
AVC
Producing to minimize economic loss.
Producing to minimize economic loss.
0.18
2.1 10
A fall in demandA fall in demand
Producing to maximize economic
profit.
Producing to maximize economic
profit.
2.4 Economic Losses in the Short run
• The shutdown point is the minimum level of average variable cost, which occurs at the intersection of the marginal cost curve and the average variable cost curve.
1,70
0
0.14
MR3
ATC
MC
AVC
Shutting down to minimize economic loss
Shutting down to minimize economic loss
2.5 Marginal Cost and Supply
MC
AVC
Industry supply
14 17 19 280 330 380
3. PERFECT COMPETITION IN THE LONG RUN
Learning Objectives1. Distinguish between economic profit and accounting profit. 2. Explain why in long-run equilibrium in a perfectly competitive
industry firms will earn zero economic profits.3. Describe the three possible effects on the costs of the factors of
production that expansion or contraction of a perfectly competitive industry may have and illustrate the resulting long-run industry supply curve in each case.
4. Explain why under perfection competition output prices will change by less than the change in production cost in the short run, but by the full amount of the change in production cost in the long run.
5. Explain the effect of a change in fixed cost on price and output in the short run and in the long run under perfect competition.
3.1 Economic Profit and Economic Loss
• Economic versus accounting concepts of profit and loss– Explicit costs are changes that must be paid for
factors of production such as labor and capital.– Accounting profit is profit computed using only
explicit costs.– Implicit cost is a cost that is included in the
economic concept of opportunity cost but that is not an explicit cost.
• The long run and zero economic profits
Eliminating Economic Profits in the Long Run
Profit = $938Profit = $938
6,7
00
0.26
MC
MR1
ATC
When firms enter supply shifts right and MR shifts down
When firms enter supply shifts right and MR shifts down
$0.22$0.22MR2
13
S1
S2
D
Eliminating Economic Losses in the Long Run
LossLoss
P1
MC
MR2
ATC
When firms exit supply shifts left and MR shifts up
When firms exit supply shifts left and MR shifts up
MR1
Q1
S2
S1
D
Q2
P1
P2P2
C1
q1 q2
3.1 Economic Profit and Economic Loss
• Entry, Exit, and Production Costs– Constant-cost industry are changes that must be
paid for factors of production such as labor and capital.
– Increasing-cost industry is profit computed using only explicit costs.
– Decreasing-cost industry is a cost that is included in the economic concept of opportunity cost but that is not an explicit cost.
– Long-run industry supply curve is a curve that relates the price of a good or service to the quantity produced after all long-run adjustments to a price change have been completed.
3.1 Economic Profit and Economic Loss
SCC
SIC
SDC
3.2 Changes in Demand and in Production Cost
$2.30
1.70C
B
A
D2
D1
S2
S1
Q3Q2Q1
$2.30
1.70
B?
A?
MCATC
MR2
MR1
q2q1
An increase in demand increases profitability which leads to an
increase in supply.
An increase in demand increases profitability which leads to an
increase in supply.
3.2 Changes in Demand and in Production Cost