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Micro Ch09 PerfectCompetition

The document outlines the key features and conditions of perfect competition as a market structure, detailing how firms decide on production levels to maximize profits. It explains the equilibrium conditions, including the shut-down and profit-maximizing rules, and emphasizes that firms are price takers in a perfectly competitive market. Additionally, it discusses the short-run and long-run equilibrium scenarios for firms and the industry, including the implications of economic profits and losses.

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Sethu Mdanyana
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24 views30 pages

Micro Ch09 PerfectCompetition

The document outlines the key features and conditions of perfect competition as a market structure, detailing how firms decide on production levels to maximize profits. It explains the equilibrium conditions, including the shut-down and profit-maximizing rules, and emphasizes that firms are price takers in a perfectly competitive market. Additionally, it discusses the short-run and long-run equilibrium scenarios for firms and the industry, including the implications of economic profits and losses.

Uploaded by

Sethu Mdanyana
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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LECTURE OUTLINES

Chapter 9: (9.1-9.7)
Market structure 1:
Overview and perfect competition
Market structure: an overview

Four different market structures


• Perfect competition

• Monopolistic competition

• Oligopoly

• Monopoly
Figure 9-1: Market structures (Textbook page 186)
Key features of a market structure:

Table 9-1: Summary of market structures (Textbook page 187)


The equilibrium conditions
(for any firm)
Two decisions:
• Should we produce? (i.e. is it worth producing?)
• If yes, how much? (i.e. quantity at which profit is
maximised or losses minimised)

• The shut-down rule – produce only if total


revenue is equal to, or greater than, total
variable cost (which includes normal profit)

• The profit-maximising rule – profit is


maximised where the positive difference
between total revenue and total cost is the
• The shut-down rule (per unit of production) –
produce only if average revenue is equal to, or
greater than, average variable cost

• The profit-maximising rule (per unit of


production ) – profit is maximised where
marginal revenue (MR) is equal to marginal cost
(MC)

• If MR > MC, output should be expanded

• If MR = MC, profits are maximised

• If MR < MC, output should be reduced


Perfect competition

• Perfect competition occurs when none of the


individual market participants (either buyers or
sellers) can influence the price of the product.
• In perfectly competitive markets, participants are
price takers – they have to accept the price as
given and can only decide what quantities to
demand or supply.
Perfect competition exists under the following
conditions:
• Large number of buyers and sellers – no buyer or
seller can affect the price; e.g. each seller only supplies
a fraction of the market.
• There is no collusion between sellers – each seller
must act independently.
• All the goods sold in the market must be identical
(homogenous) – gives buyers no reason to prefer the
product of one seller over another.
• Buyers and sellers should have complete freedom
to enter or exit the market – there must be no
barriers to entry in the form of e.g. legal, financial,
technological, physical or other restrictions which inhibit
8
the movement of buyers and sellers.
Perfect competition exists under the following
conditions:
• All buyers and sellers must have perfect
knowledge of market conditions, e.g. if a firm
increases its price to above market price, it is
assumed that the buyers will know.
• There must be no government intervention
influencing buyers and sellers.
• Factors of production must be perfectly mobile
– e.g. labour or capital should be able to move
freely between the markets.

9
The demand for
the product of the firm
• Under perfect competition, the price of the
product is determined by supply and demand –
in the MARKET.
• The individual firm is a price taker and can sell
any quantity at the given market price.
• The individual firm cannot charge a price higher
than the market price – if it does, no one will buy
from them.
• The individual firm also has nothing to gain from
charging a lower price – it can sell as many
goods as it wants at the market price.
• The demand curve for the product of the firm is a
horizontal line at the market price (perfectly
elastic)
Figure 9-2: The demand curve for the product of the firm under perfect
competition (Textbook page 194)
The demand curve of the firm under
perfect competition

• Under perfect competition the firm receives the


same price for any of the units of the product
that it sells.
• The marginal revenue (MR) and average revenue
(AR) are both equal to the price; MR = AR = P.
• Total revenue (TR) = price (P) x quantity (Q);
under perfect competition, each additional unit
sold therefore increases total revenue by the
price of the product.
12
The demand curve of the firm
under perfect competition
• Each additional unit
sold increases total
revenue by the price
of the product.
• The firms total
revenue curve can be
represented by a
straight line , with a
slope equal to the
price of the product.
13
Short run equilibrium of the firm
under perfect competition

• How do firms decide whether, and how


much of a good they should produce if
they want to maximise profit?
• Economic profit = TR – TC
(Remember it’s economic profit, which
includes normal profit).

14
Short run equilibrium of the firm
under perfect competition

• Maximising profit
– Using –
Total cost and
total revenue

• Maximise profit
where the positive
difference between
TR and TC is at a
maximum.

15
The equilibrium of the firm
under perfect competition

• Profit is maximised (or losses minimised) when a


firm produces an output where marginal revenue
(=price) equals marginal cost, provided marginal
cost is rising and lies above minimum average
variable cost
Short run equilibrium of the firm
under perfect competition
 Per unit of production: profit is
maximised where marginal
revenue (MR) equals
marginal cost (MC).
 When looking at the
equilibrium position of the
firm, we can disregard the
falling section of the MC
curve. Why?
 Initially making a loss;
then MR is above MC, so
any increase in production
(quantity) will still bring
additional profits to the
firm. 17
EXAMPLE 1

Table 9-2: revenue and cost of a hypothetical firm (Textbook page 197)
EXAMPLE 2

Figure 9-3: Marginal revenue and marginal cost of a firm operating in a


perfectly competitive market (Textbook page 197)
Short run equilibrium of the firm
under perfect competition

• Does profit maximisation by the firm (in a


perfectly competitive market) also imply
economic profit????
– Not necessarily!!! Have to first determine whether
covering all costs (fixed and variable)
– check whether the average revenue from
producing a certain amount of goods covers the
average cost of producing it.

20
• Different possible short-run equilibrium positions
of the firm under perfect competition
– Economic profit
– Break even
– Economic loss
Figure 9-4: Different possible short-run equilibrium positions of the firm under
perfect competition (Textbook page 199)

(If AR > AC)


(If AR = AC)
(If AR < AC)
The supply curve of the firm and
the market supply curve
• Firm’s supply
curve – the rising
part of the firm’s
MC curve above
the minimum of
AVC

Figure 9-5: The supply curve of


the firm (Textbook page 200)
• Why does the Supply Curve slope
upward?
…..because the MC curve slopes upward
(law of diminishing returns).

• Market supply curve – add the supply


curves of the individual firms horizontally
Long-run equilibrium of the firm and
the industry under perfect
competition

• The industry will be in equilibrium in the long run


only if all the firms are making normal profits
Figure 9-6: The firm and industry in equilibrium (Textbook page 203)
• If firms are making an economic profit – new
firms enter the market

Figure 9-7: The individual firm and the industry when the firm initially earns an
economic profit (Textbook page 203)
• If firms are making an economic loss –
existing firms exit the market

Figure 9-8: The individual firm and the industry when the firm initially makes
an economic loss (Textbook page 204)

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