Perfect Comptt

8/8/2019 Perfect Comptt

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Perfect

Competition


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Perfect Competition

It is that market structure in which a

large number of sellers and buyersmature their transactions. The productare homogeneous.


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Assumptions

There are many sellers and many buyers.

The products sold by the firms are identical(Homogeneous).

Entry into and exit from the market are easy,

No single firm can change the price of

product Buyers (consumers) and sellers (firms) haveperfect information


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Equilibrium Conditions

There are two equilibrium conditions

marginal revenue (MR) must beequal to marginal cost (MC).

Slope of Marginal Revenue must be

less than Slope of Marginal Cost


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Profit-Maximizing Level ofOutput Marginal revenue (MR) the change

in total revenue associated with achange in quantity.

Marginal cost(MC) the change in totalcost associated with a change in quantity.


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Marginal Revenue

TR =P*Q

MR = dTR/dQ AR = TR/Q or P*Q/Q OR AR= P

So if Price does not change then there

would be no change in MR .In short P=AR=MR


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According to theassumption, ifprice remains

same then MRand AR wouldalso equal toPrice

P Q TR MR AR

10 1 10 10 10

10 2 20 10 10

10 3 30 10 10

10 4 40 10 1010 5 50 10 10


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Profit Maximization: MC = MR

To maximize profits, a firm should

produce where marginal cost equalsmarginal revenue.


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How to Maximize Profit

The supplier will cut back on production

if marginal cost is greater than marginalrevenue.

Thus, the profit-maximizing condition of a

competitive firm is MC = MR = P.


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Possibilities of Profit and lossin Perfect Competition

There are four possibilities in Short run

Normal profit AR =AC

Normal Loss AR < AC

Abnormal Profit AR >> AC

Abnormal Loss AR


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C

A

P = AR =

MR

Costs

12 3 4 5 6 78 910Quantity

60

5040

30

2010

0

A

B

MC

Marginal Cost, Marginal

Revenue, and Price

0

123456789

10

$28.0020.0016.0014.0012.0017.00

22.0030.0040.0054.0068.00

Price = MRQuantityProduce

d

Marginal

Cost$35.00

35.0035.0035.0035.0035.0035.0035.0035.0035.0035.00

McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., AllRights Reserved.


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Profit Maximization


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Profit Maximization: The

Numbers

Q P TR TC TR-TC MR MC ATC

0 $1 $0 $1.00 -$1.00 $1

1 $1 $1 $2.00 -$1.00 $1 $1.00 $2.00

2 $1 $2 $2.80 -$0.80 $1 $0.80 $1.40

3 $1 $3 $3.50 -$0.50 $1 $0.70 $1.174 $1 $4 $4.00 $0.00 $1 $0.50 $1.00

5 $1 $5 $4.50 $0.50 $1 $0.50 $0.90

6 $1 $6 $5.20 $0.80 $1 $0.70 $0.87

7 $1 $7 $6.00 $1.00 $1 $0.80 $0.86

8 $1 $8 $6.86 $1.14 $1 $0.86 $0.86

9 $1 $9 $7.86 $1.14 $1 $1.00 $0.87

10 $1 $10 $9.36 $0.64 $1 $1.50 $0.94

11 $1 $11 $12.00 -$1.00 $1 $2.64 $1.09

MR=MCMR=MC


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The Marginal Cost Curve isthe Supply Curve The marginal cost curve is the firm's

supply curve above the point whereprice exceeds average variable cost.


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The Marginal Cost Curve isthe Supply Curve The MC curve tells the competitive firm

how much it should produce at a givenprice.

The firm can do not better than produce

the quantity at which marginal cost equalsmarginal revenue which in turn equalsprice.


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The Marginal Cost Curve is

the Firms Supply Curve

A

B

CMarginal cost

C

ost,

Price

$70

60

50

40

30

20

10

0 1 Quantity2 3 4 5 6 7 8 9 10


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Firms Maximize TotalProfit Firms seek to maximize total profit, not

profit per unit. Firms do not care about profit per unit. As long as increasing output increases

total profits, a profit-maximizing firm shouldproduce more.


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Profit Maximization UsingTotal Revenue and Total Cost

Profit is maximized where the vertical

distance between total revenue andtotal cost is greatest.

At that output, MR(the slope of the

total revenue curve) andMC

(the slopeof the total cost curve) are equal.


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TC TR

0

Totalcost,

reve

nue

$385350

315280245210175140105

7035

Quantity1 2 3 4 5 6 7 8 9

Profit Determination Using Total

Cost and Revenue Curves

Maximum profit =$81

$130

Loss

Loss

Profit

Profit =$45



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Total Profit at the Profit-Maximizing Level of Output

The P = MR = MC condition tells us

how much output a competitive firmshould produce to maximize profit.

It does not tell us how much profit the

firm makes.


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Determining Profit and Loss

From a Table of Costs

Profit can be calculated from a table of

costs and revenues. Profit is determined by total revenue

minus total cost.


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Costs Relevant to a Firm



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Costs Relevant to a Firm



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Determining Profit and

Loss From a Graph Find output where MC = MR.

The intersection ofMC = MR(P)determines the quantity the firm willproduce if it wishes to maximize profits.


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Loss From a Graph Find profit per unit where MC = MR.

Drop a line down from where MC equals MR,and then to the ATC curve.

This is the profit per unit.

Extend a line back to the vertical axis toidentify total profit.


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Loss From a Graph The firm makes a profit when the ATC

curve is below the MR curve.

The firm incurs a loss when the ATC curveis above the MR curve.


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) Profit case (b) Zero profit case (c) Loss case

Determining Profits Graphically

Quantity Quantity Quantity

Price65605550

454035302520

151050

65605550

454035302520

151050

1 234567891012 1 234567891012

D

MC

A P = MR

B ATC

AVCE

Profit

C

MC

ATC

AVC

MC

ATC

AVC

Loss

65605550

454035302520

151050

123456789 10

12

P = MR

P = MR

Price Price

The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill


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Loss Minimization

Average cost of a unit of outputAverage cost of a unit of output

RevenueRevenue

generated by agenerated by a

unit of outputunit of output

MarketMarket

priceprice

fallsfalls


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The Shutdown Point

The firm will shut down if it cannot

cover average variable costs. A firm should continue to produce as longas price is greater than average variablecost.

If price falls below that point it makessense to shut down temporarily and savethe variable costs.


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The Shutdown Point

If total revenue is more than total

variable cost, the firms best strategy isto temporarily produce at a loss.

It is taking less of a loss than it would byshutting down.


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MC

P = MR

2 4 6 8 Quantity

Price

60

50

40

30

20

10

0

ATC

AVC

Loss

A$17.80

The Shutdown Decision


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Perfect Competition

Long Run


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Normal Profit in the Long Run Entry and exit occur whenever firms are earning

more or less than normal profit (zero

economic profit). If firms are earning more than normal profit, other firmswill have an incentive to enter the market.

If firms are earning less than normal profit, firms in the

industry will have an incentive to exit the market.


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Profit$9

10120

FirmPrice

Quantity

B

A

Market Response to an Increase in

DemandMarket

Quantity

Price

0

B

A

C

MC

AC

SLR

S0SR

D0

7

700

$9

8401,200

D1

S1SR

7



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Practice Questions

A firm faces a demand curveand cost curves . Find the

profit maximizing output (Q)at which the profit ismaximum.

10

2100

==

=

MCAC

PQ


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Practice Question

12000200

1042.0300

1 23

+=

++=

PQ

qqqTC

1. Calculate the short run supply curve from the giveninformation's

2. Find short run equilibrium output and price.

Perfect Comptt

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