PERFECTLY COMPETITIVE

MARKETS

MAIN ASSUMPTION OF PERFECT COMPETITION

 many small firms (too small to affect the market price) identical product  free entrance inwards and outwards the market (no

barriers)  perfect information firms produce and sell their output at given market

prices firms are so called „price-takers“under such conditions, each producer faces a

completely horizontal demand curve

Revenues in perfect competition

• Total revenues depend exclusively on the quantity of production and are directly proportional to it

• AR are constant the AR curve is straight line parallel with the X-axis at the level of given price

• MR curve is identical to AR curve

COMPETITIVE SUPPLY

• A typical perfect competitor will be able to sell any amount of output at the going market price. Under perfect competition, a profit-maximizing firm will set its production at the level where marginal cost equals price

• P = MC• what will happen, if the market price changes? –

when increases, it will cause the change in firms optimal output along the rule P = MC this means that a firm’s marginal cost curve is also its supply curve!

Relative loss – decline in achieved profit by producing more than is optimal,

Absolute loss – real loss in case the total costs exceed the total revenue,

Opportunity cost – in case firm produce less Q than corresponds to economic equilibrium.

Relative, Absolute loss and Opportunity cost

Optimum of Firm, Relative Loss and Opportunity Cost

Q*

MC

AC

EUR/Q

Q

RELATIVE LOSS

OPPORTUNITY COST

Q2 Q1

MR = AR = d

THE SHOTDOWN CONDITION – IN THE SHORT RUN

the critically low market price at which revenues just equal variable cost (or at which losses exactly equal fixed costs) is called the SHUTDOWN POINT

– for prices above the shutdown point, the firm will produce along its marginal cost curve, for prices below the shutdown point, the firm will produce nothing at all

The Shotdown Condition in the Short Run

QSD Q

EUR/Q

AC

AVC

ZTRÁTA

MC

MR= AR = d

QSD Q

EUR/Q

AC

AVC

ZTRÁTA

MC

MR= AR = d

QSD Q

EUR/Q

AC

AVC

ZTRÁTA

MC

MR= AR = d

QSD Q

EUR/Q

AC

AVC

ZTRÁTA

MC

MR= AR = d

BREAKEVEN POINT

price is equal to AC, means total revenues just cover total costs

in a long run is unacceptable the situation, where the total cost are higher than total revenues (and the price lower than AC), because firms would tend to leave this market the long-run breakeven condition comes at a critical P where identical firms just cover their full competitive costs

- the long-run equilibrium condition of firm can be summed up:

MR = MC = AC = AR, alias P = MC = AC

THE EFFICIENCY OF COMPETITIVE MARKETS

• 1. P = MU Everybody gains P utils of satisfaction from the last unit of good

• 2.  P = MC The price of good exactly equals the MC of the last unit of good supplied

• 3.   MU = MC The marginal gains to society from the last consumed unit equal to the marginal costs to society of that last unit produced, which guarantees that a competitive equilibrium is efficient.

Tasks: Compare the price and quantity produced in perfect competition in the

short- and long-run. Price of the short run is 15,- EUR, set the price of the long run.

Decide about the optimal quantity of production and the shotdown point of perfectly competitive firm in the short run knowing: the price 95,- Eur, fixed costs = 2 and

Q 1 2 3 4 5 6 7

TC 20 30 33 36 50 78 112

Q 1 2 3 4 5 6 7

AC 40 38 37 40 46 54 63