PERFECT COMPETITIONPERFECT COMPETITION(OPTIMAL PRODUCTION IN A PERFECT (OPTIMAL PRODUCTION IN A PERFECT
COMPETITIVE MARKET)COMPETITIVE MARKET)
STUDY UNIT 9STUDY UNIT 9
PRESCRIBED BOOK CHAPTER PRESCRIBED BOOK CHAPTER 1212
2
SOME OF THE STUDY OBJECTIVESSOME OF THE STUDY OBJECTIVES
Define and indicate what the characteristics of a perfect Define and indicate what the characteristics of a perfect competitive market arecompetitive market are
Explain the demand curve of under perfect competitionExplain the demand curve of under perfect competition
Draw the demand curve for a single firm under perfect Draw the demand curve for a single firm under perfect competitioncompetition
Determine where profit is maximised in the short-termDetermine where profit is maximised in the short-term
Indicate whether a firm records economic profit, normal profit or Indicate whether a firm records economic profit, normal profit or an economic loss graphicallyan economic loss graphically
Determine the shut-down/open-up point.Determine the shut-down/open-up point.
3
CHARACTERISTICS OF A PERFECT CHARACTERISTICS OF A PERFECT COMPETITIVE MARKETCOMPETITIVE MARKET
DEFINITION: DEFINITION: Perfect competition occurs when Perfect competition occurs when nonenone of of
the the individualindividual market participants (buyers & sellers) market participants (buyers & sellers)
can influence the price of the product.can influence the price of the product.
-- They are price takers and quantity adjusters.They are price takers and quantity adjusters.
REQUIREMENTS:REQUIREMENTS:
Large number of buyers and sellersLarge number of buyers and sellers
No collusion between sellers – each one acts independentlyNo collusion between sellers – each one acts independently
Homogeneous (identical) product is soldHomogeneous (identical) product is sold
Freedom of exit and entry to the marketFreedom of exit and entry to the market
Perfect informationPerfect information
No government interventionNo government intervention
Production factors are mobileProduction factors are mobile
4
Individual demand curve for the firmIndividual demand curve for the firm
0
200
400
600
800
1000
1200
Quantity Market
Pri
ce
0
100
200
300
400
500
600
700
0 50 100 150 200
QUANTITY OF FIRM
PRIC
E
D
S
D=AR=MR=P
5Chapter 12 Perfect competition© Van Schaik Publishers
Figure 12-1 The demand curve for the product of the firm under perfect
competition
6
QuantityQuantity Price per Price per unit (R)unit (R)
TR = P x TR = P x QQ
MRMR ARAR
00 600600 00 00 00
5050 600600 30 00030 000 30 000 30 000 ÷ ÷ 5050
600600
600600
100100 600600 60 00060 000 30 000 30 000 ÷ ÷ 5050
600600
600600
150150 600600 90 00090 000 30 000 30 000 ÷ ÷ 5050
600600
600600
200200 600600 120 000120 000 30 000 30 000 ÷ ÷ 5050
600600
600600
250250 600600 150 000150 000 30 000 30 000 ÷ ÷ 5050
600600
600600
7
PROFIT POSITION IN THE SHORT-TERMPROFIT POSITION IN THE SHORT-TERM
Determine profit in short-term according toDetermine profit in short-term according to::
Total approach (not prescribed) Total approach (not prescribed) - Firm produces where profit (TR – - Firm produces where profit (TR –
TC) is the highestTC) is the highest
Shut-down (start-up) rule (prescribed book p 227) Shut-down (start-up) rule (prescribed book p 227) – Revenue: – Revenue:
TR = or greater than TVC; Unit Costs: AR (p) = or greater than AVCTR = or greater than TVC; Unit Costs: AR (p) = or greater than AVC
Marginal Approach (the profit-maximising rule)Marginal Approach (the profit-maximising rule)
MR = MCMR = MC
Differentiate between:Differentiate between:
Economic profitEconomic profit
Normal ProfitNormal Profit
Economic lossEconomic loss
8
TOTAL APPROACHTOTAL APPROACH
QUANTITYQUANTITY PRICEPRICE TRTR TCTC PROFITPROFIT
00 66 00 33 -3-3
11 66 66 55 11
22 66 1212 88 44
33 66 1818 1212 66
44 66 2424 1717 77
55 66 3030 2323 77
66 66 3636 3030 66
77 66 4242 3838 44
88 66 4848 4747 11
99 66 5454 5959 -5-5
9Chapter 12 Perfect competition© Van Schaik Publishers
Box 12-3Marginal cost and profit maximisation
10
MARGINAL APPROACHMARGINAL APPROACH
QQ PP TRTR MRMR TCTC MCMC ACAC PROFITPROFIT
00 66 00 00 33 00 00 -3-3
11 66 66 66 55 22 55 11
22 66 1212 66 88 33 44 44
33 66 1818 66 1212 44 44 66
44 66 2424 66 1717 55 4,254,25 77
5 6 30 6 23 6 4,60 7
66 66 3636 66 3030 77 55 66
77 66 4242 66 3838 88 5,435,43 44
88 66 4848 66 4747 99 5,885,88 11
99 66 5454 66 5959 1212 6,556,55 -5-5
1010 66 6060 66 7373 1414 7,307,30 -13-13
11
MARGINAL APPROACH GRAPHICALLYMARGINAL APPROACH GRAPHICALLY
0
2
4
6
8
10
12
0 1 2 3 4 5 6 7 8 9 10
QUANTITY
PR
ICE
, M
R,M
C
MC
MR = PProfit
increases
MR>MC
Profit
decreases
MC>MRProfit maximised MR=MC
12Chapter 12 Perfect competition© Van Schaik Publishers
Figure 12-5 Marginal revenue and marginal cost of a firm operating in a perfectly competitive
market
13
PROFIT AND LOSS POSITIONSPROFIT AND LOSS POSITIONS
Economic profit:Economic profit: P > minimum of ACP > minimum of AC TR > TCTR > TC MR > MCMR > MC
Normal ProfitNormal Profit P = minimum of ACP = minimum of AC TR = TCTR = TC MR = MCMR = MC
Economic lossEconomic loss P < minimum of ACP < minimum of AC TR < TCTR < TC MR < MC MR < MC
Market supply curve –figure 12.7 (see later)Market supply curve –figure 12.7 (see later)
14
SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC PROFITTHE FIRM – AN ECONOMIC PROFIT
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7 8 9 10
QUANTITY
PR
ICE
, MR
,MC
MC
MR = P
ACE
M
15
SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – NORMAL PROFITTHE FIRM – NORMAL PROFIT
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7 8 9 10
QUANTITY
PR
ICE
, MR
,MC
MC
MR = P
AC
E
16
SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC LOSSTHE FIRM – AN ECONOMIC LOSS
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7 8 9 10
QUANTITY
PR
ICE
, MR
,MC
MC
MR = P
AC
E
M
17Chapter 12 Perfect competition© Van Schaik Publishers
Figure 12-6 Different possible short-run equilibrium positions of the firm under
perfect competition
18
THE FIRM’S SUPPLY CURVETHE FIRM’S SUPPLY CURVE
Cost, Price (Rand)
Output/day
MC AC
AVC
8.0
12.0
Price 20.0
60 80 100
A
B
C
19Chapter 12 Perfect competition© Van Schaik Publishers
Figure 12-7 The supply curve of the firm
20
CHANGES IN THE LONG RUN IF THE FIRM RECORDS AN ECONOMIC PROFIT IN SHORT
RUN
0
200
400
600
800
1000
1200
1400
1600
0 100 200 300 400 500 6000
200
400
600
800
1000
1200
1400
0 100 200 300 400 500 600
MC
AC
MR
MR1
E
E1
DS
S1
E
E1
21
CHANGES IN THE LONG RUN IF THE FIRM RECORDS AN ECONOMIC LOSS IN SHORT
RUN
0
200
400
600
800
1000
1200
1400
1600
0 100 200 300 400 500 6000
200
400
600
800
1000
1200
1400
0 100 200 300 400 500 600
MC
AC
MR
MR1
E
E1
D
S
S1
E
E1
22
D S
D
Market Firm
EXPLAIN WHY UNDER PERFECT COMPETITION THE INDIVIDUAL FIRM IS FACED BY A PERFECT ELASTIC DEMAND CURVE
23
DRAW A GRAPH THAT INDICATES WHERE THE PERFECT COMPETITIVE FIRM IS MAKING NORMAL PROFIT IN THE SHORT RUN.
24
SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – NORMAL PROFITTHE FIRM – NORMAL PROFIT
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7 8 9 10
QUANTITY
PR
ICE
, MR
,MC
MC
MR = P
AC
E
25
EXAM QUESTIONS SHORT-RUN EQUILIBRIUMEXAM QUESTIONS SHORT-RUN EQUILIBRIUM
0
200
400
600
800
1000
1200
0 Q1 Q2 Q3 Q4 Q5
QUANTITY
PR
ICE
H
G
K
C
A
26
QUESTION RELATING TO SLIDE 25QUESTION RELATING TO SLIDE 25
Curve H represents which curve?Curve H represents which curve?
Name curve K? Name curve K?
At which quantity is profit maximised?At which quantity is profit maximised?
What does the price line represent?What does the price line represent?
The short-run supply curve of the firm is from?The short-run supply curve of the firm is from?
Is this firm earning an economic profit, normal profit or Is this firm earning an economic profit, normal profit or economic loss?economic loss?
What does the vertical distance between curve H and G What does the vertical distance between curve H and G represent?represent?
27
SHORT-RUN EQUILIBRIUMSHORT-RUN EQUILIBRIUM
0
0.2
0.4
0.6
0.8
1
1.2
0 Q1 Q2 Q3 Q4 Q5
QUANTITY
PR
ICE
28
QUESTION RELATING TO SLIDE 27QUESTION RELATING TO SLIDE 27
Name the 2 curves?Name the 2 curves?
Illustrate an economic loss on the graph with the aid of a Illustrate an economic loss on the graph with the aid of a shaded area?shaded area?
29
SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC LOSSTHE FIRM – AN ECONOMIC LOSS
AC
E
M
30
Examination questionsExamination questions
What is the profit maximising rule for the firm in a perfectly What is the profit maximising rule for the firm in a perfectly competitive market which applies the marginal approach?competitive market which applies the marginal approach?
When will a firm increase production according to the When will a firm increase production according to the marginal approach?marginal approach?
When will a firm reduce its production using the marginal When will a firm reduce its production using the marginal approach?approach?
31
THE FIRM’S SUPPLY CURVETHE FIRM’S SUPPLY CURVE
Cost, Price (Rand)
Output/day
MC AC
AVC
8.0
12.0
Price 20.0
60 80 100
A
B
C
32
Questions Relating to slide 31 Questions Relating to slide 31
What is the firm's profit-maximising daily output? What is the total daily revenue of the profit-maximising
firm? Total daily costs to the firm is? At which price will it be immaterial for the firm if it shuts
down or continues production? At what point will the firm minimize its economic loss?
What will the firm earn at a price of R20? Briefly explain
why? Briefly explain the concept break even. Also indicate at
which corresponding point on the figure this situation will occur.
33
Questions Relating to slide 31 Questions Relating to slide 31
The vertical distance between AC and AVC represents?
What part of the firm's MC curve can be regarded as
the firm's supply curve?
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