Perfect Competition

Perfect Competition

A2 Economics

Aims and Objectives

Aim:• Understand perfectly competitive markets

Objectives:• Explain the long run equilibrium of perfectly

competitive firms.• Analyse the process of perfectly competitive firms

making losses.• Evaluate the strategies of persistently loss making

firms.

Starter

• Draw a firm in perfect competition making supernormal profit.

Quantity Demanded and Supplied

Revenue & Cost of X

D=AR=MR=P

100

£80

£60

MC

ATC

Price of X


D

£80

SRevenue & Cost

D=AR=MR=P

100 0

The FirmThe Market

MC

S1

£60D=AR=MR=P1

8

ATC

£80

£60

• Draw the diagram to show Supernormal profit being eroded away and explain.

Long Run Equilibrium: Normal Profit

• The firm is in equilibrium in the long run, making normal profits where ATC = AR.

• Equilibrium output at MC=MR is also where ATC is at its lowest point (productive efficiency).


Revenue & Cost

0

The Firm

MC

D=AR=MR=P

Q

ATC

P

Long Run Equilibrium: Normal Profit

• This point is also allocatively efficient – best allocation of resources to meet demand.

• Firms in perfect comp. are likely to be statically efficient – both allocative and productive efficiency.


Revenue & Cost

0

The Firm

MC

D=AR=MR=P

Q

ATC

P

Dynamic Efficiency

Definition:• Efficiency over time – new products,

techniques and processes which increase economic growth.

• Essential for building supernormal profits.• However, firms in perfect competition are

unlikely to be dynamically efficient as supernormal profits cannot be maintained due to free barriers to entry/perfect knowledge.

An Example of Perfect Competition? The Internet Economy: Towards A Better Future

Is the internet economy an example of perfect competition?

How many of the assumptions apply to this industry?

Firms Making Losses

• At market price of £60 the firm is making losses as at output of 8 units , the ATC is £82 whereas the AR is only £60, therefore £22 losses are being made per unit.

Price of X


D

£80

SRevenue & Cost

D=AR=MR=P1

100 0

The FirmThe Market

MC

S1

£60D=AR=MR=P

8

ATC

£80

£60

£82

Firms Making Losses

• Firm producing at MC=MR- meaning it is making the smallest loss possible.

• If firms are making losses some will leave the industry (S – S1).

Price of X


D

£80

S1Revenue & Cost

D=AR=MR=P1

100 0

The FirmThe Market

MC

S

£60D=AR=MR=P

8

ATC

£80

£60

£82

Firms Making Losses

• This will lead to higher price of £80.• Here the firm is making normal profit as ATC=AR (10 units)• The firms market share has increased as firms have left the industry.

Price of X


D

£80

S1Revenue & Cost

D=AR=MR=P1

100 0

The FirmThe Market

MC

S

£60D=AR=MR=P

8

ATC

£80

£60

£82

SPEED DATING

Firms Entering and Leaving The Industry

• Firm producing at MR=MC.• TR = £5000, TC = £6000, Firm is making losses of £1000 per week!


Revenue & Cost

1000

The FirmMC

D=AR=MR=P

ATC

£50

£40

£60AVC

TFC


Does the firm shut down immediately? Or close down slowly?• Depends on relationship between AVC and P.• AVC = £4000, ATC = £6000, TFC = £2000.• Firm faces TFC of £2000 which must be paid

whether the firm produces or not.• At present running the firm = £1000 Loss• Running firm paying £1000 towards TFC


• Shutting down immediately would result in shareholders paying TFC immediately - £2000.

• Therefore if P is above AVC it pays the firm to continue production to offset some part of its fixed costs and close down slowly.

• If P falls below AVC there is no point in carrying on and the firm should shut down immediately.

Worksheet

• Explain what level of output the firm will produce and why.

• What is the firms’ level of losses at this output level?

• You have been called in to advise the managing director as to whether the firm should close immediately. Write a brief to explain the costs/benefits of the firm’s options.

Perfect Competition

Documents

Transcript of Perfect Competition