Team Member’s
Varun Aggarwal
Jyoti chauhan
Shashank Rana
Preeti Pawaria
Rahul Yadav
Vijay Kundra
Nitin Kumar
Sapna Rana
Perfect Competition
Perfect Competition
The concept of competition is used in two
ways in economics.
Competition as a process is a rivalry among
firms.
Competition as the perfectly competitive
market structure.
A Perfectly Competitive
Market
A perfectly competitive market is one in
which economic forces operate
unimpeded.
A Perfectly Competitive
Market
A perfectly competitive market must meet
the following requirements:
Both buyers and sellers are price takers.
The number of firms is large.
There are no barriers to entry.
The firms’ products are identical.
There is complete information.
Firms are profit maximizers.
The Necessary Conditions for
Perfect Competition
Both buyers and sellers are price takers.
A price taker is a firm or individual who takes
the market price as given.
In most markets, households are price takers –
they accept the price offered in stores.
The Necessary Conditions for
Perfect Competition
Both buyers and sellers are price takers.
The retailer is not perfectly competitive.
A retail store is not a price taker but a price
maker.
The Necessary Conditions for
Perfect Competition
The number of firms is large.
Large means that what one firm does has no
bearing on what other firms do.
Any one firm's output is minuscule when
compared with the total market.
The Necessary Conditions for
Perfect Competition
There are no barriers to entry.
Barriers to entry are social, political, or
economic impediments that prevent other
firms from entering the market.
Barriers sometimes take the form of patents
granted to produce a certain good.
The Necessary Conditions for
Perfect Competition
There are no barriers to entry.
Technology may prevent some firms from
entering the market.
Social forces such as bankers only lending to
certain people may create barriers.
The Necessary Conditions for
Perfect Competition
The firms' products are identical.
This requirement means that each firm's
output is indistinguishable from any
competitor's product.
The Necessary Conditions for
Perfect Competition
There is complete information.
Firms and consumers know all there is to
know about the market – prices, products,
and available technology.
Any technological breakthrough would be
instantly known to all in the market.
The Necessary Conditions for
Perfect Competition
Firms are profit maximizers.
The goal of all firms in a perfectly competitive
market is profit and only profit.
The only compensation firm owners receive is
profit, not salaries.
The Definition of Supply and
Perfect Competition
If all the necessary conditions for perfect
competition exist, we can talk formally
about the supply of a produced good.
The Definition of Supply and
Perfect Competition
Supply is a schedule of quantities of
goods that will be offered to the market at
various prices.
The Definition of Supply and
Perfect Competition
When a firm operates in a perfectly
competitive market, it’s supply curve is that
portion of its short-run marginal cost curve
above average variable cost.
Demand Curves for the Firm
and the Industry
The demand curves facing the firm is
different from the industry demand curve.
A perfectly competitive firm’s demand
schedule is perfectly elastic even though
the demand curve for the market is
downward sloping.
Demand Curves for the Firm
and the Industry
Individual firms will increase their output in
response to an increase in demand even
though that will cause the price to fall thus
making all firms collectively worse off.
Market Demand Versus
Individual Firm Demand Curve
Market Firm
Price Market supply Price
$10 $10
8 8 Individual firm
6 6 demand
4 Market 4
2 demand 2
0 0
1,000 3,000 Quantity 10 20 30 Quantity
Profit-Maximizing Level of
Output
The goal of the firm is to maximize profits.
Profit is the difference between total
revenue and total cost.
Profit-Maximizing Level of
Output
What happens to profit in response to a
change in output is determined by marginal
revenue (MR) and marginal cost (MC).
A firm maximizes profit when MC = MR.
Profit-Maximizing Level of
Output
Marginal revenue (MR) – the change in
total revenue associated with a change in
quantity.
Marginal cost (MC) – the change in total
cost associated with a change in quantity.
Marginal Revenue
A perfect competitor accepts the market
price as given.
As a result, marginal revenue equals price
(MR = P).
Marginal Cost
Initially, marginal cost falls and then begins
to rise.
Marginal concepts are best defined
between the numbers.
Profit Maximization: MC = MR
To maximize profits, a firm should produce
where marginal cost equals marginal
revenue.
How to Maximize Profit
If marginal revenue does not equal
marginal cost, a firm can increase profit by
changing output.
The supplier will continue to produce as
long as marginal cost is less than marginal
revenue.
How to Maximize Profit
The supplier will cut back on production if
marginal cost is greater than marginal
revenue.
Thus, the profit-maximizing condition of a
competitive firm is MC = MR = P.
Marginal Cost, Marginal
Revenue, and Price
Costs MC
Price = MR Quantity Marginal
Produced Cost
$35.00 0 60
$28.00
35.00 1
20.00 50
35.00 2 16.00
35.00 3 40 A C
35.00 4
14.00 P = D = MR
12.00 30 B
35.00 5 A
17.00
35.00 6 22.00 20
35.00 7 30.00
35.00 8 10
40.00
35.00 9 54.00 0
35.00 10 68.00 1 2 3 4 5 6 7 8 9 10 Quantity
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
The Marginal Cost Curve Is the
Supply Curve
The marginal cost curve is the firm's supply
curve above the point where price exceeds
average variable cost.
The Marginal Cost Curve Is the
Supply Curve
The MC curve tells the competitive firm
how much it should produce at a given
price.
The firm can do no better than produce the
quantity at which marginal cost equals
marginal revenue which in turn equals
price.
The Marginal Cost Curve Is the
Firm’s Supply Curve
$70 Marginal cost
C
60
50
Cost, Price
40 A
30
20 B
10
0 1 2 3 4 5 6 7 8 9 10 Quantity
Firms Maximize Total Profit
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 should
produce more.
Profit Maximization Using
Total Revenue and Total Cost
Profit is maximized where the vertical
distance between total revenue and total
cost is greatest.
At that output, MR (the slope of the total
revenue curve) and MC (the slope of the
total cost curve) are equal.
Profit Determination Using Total
Cost and Revenue Curves
TC TR
$385 Loss
Total cost, revenue
350
315 Maximum profit =$81 Profit
280
245
210 $130
175
140
105 Profit =$45
70
35 Loss
0
1 2 3 4 5 6 7 8 9 Quantity
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Total Profit at the Profit-
Maximizing Level of Output
The P = MR = MC condition tells us how
much output a competitive firm should
produce to maximize profit.
It does not tell us how much profit the firm
makes.
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.
Costs Relevant to a Firm
Profit Maximization for a Competitive Firm
Marginal Average Total Profit
P = MR Output Total Cost
Cost Total Cost Revenue TR-TC
— 0 40.00 — — 0 –40.00
35.00 1 68.00 28.00 68.00 35.00 –33.00
35.00 2 88.00 20.00 44.00 70.00 –18.00
35.00 3 104.00 16.00 34.67 105.00 1.00
35.00 4 118.00 14.00 29.50 140.00 22.00
35.00 5 130.00 12.00 26.00 175.00 45.00
35.00 6 147.00 17.00 24.50 210.00 63.00
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Costs Relevant to a Firm
Profit Maximization for a Competitive Firm
Marginal Average Total Profit
P = MR Output Total Cost
Cost Total Cost Revenue TR-TC
35.00 4 118.00 14.00 29.50 140.00 22.00
35.00 5 130.00 12.00 26.00 175.00 45.00
35.00 6 147.00 17.00 24.50 210.00 63.00
35.00 7 169.00 22.00 24.14 245.00 76.00
35.00 8 199.00 30.00 24.88 280.00 81.00
35.00 9 239.00 40.00 26.56 315.00 76.00
35.00 10 293.00 54.00 29.30 350.00 57.00
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Determining Profit and Loss
From a Graph
Find output where MC = MR.
The intersection of MC = MR (P) determines
the quantity the firm will produce if it wishes
to maximize profits.
Determining Profit and 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 to
identify total profit.
Determining Profit and 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 curve
is above the MR curve.
Determining Profit and Loss From
a Graph
Zero profit or loss where MC=MR.
Firms can earn zero profit or even a loss
where MC = MR.
Even though economic profit is zero, all
resources, including entrepreneurs, are being
paid their opportunity costs.
Determining Profits Graphically
Price MC Price MC Price MC
65 65 65
60 60 60
55 55 55
50 50 50 ATC
45 45 ATC 45
40 D A P = MR 40 40 Loss P = MR
35 35 35
Profit P = MR
30 B ATC 30 30 AVC
25 C AVC 25 AVC 25
20 E 20 20
15 15 15
10 10 10
5 5 5
0 0 0
1 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 910 12
Quantity Quantity Quantity
(a) Profit case (b) Zero profit case (c) Loss case
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2000
The Shutdown Point
The firm will shut down if it cannot cover
average variable costs.
A firm should continue to produce as long as
price is greater than average variable cost.
If price falls below that point it makes sense to
shut down temporarily and save the variable
costs.
The Shutdown Point
The shutdown point is the point at which
the firm will be better off it shuts down than
it will if it stays in business.
The Shutdown Point
If total revenue is more than total variable
cost, the firm’s best strategy is to
temporarily produce at a loss.
It is taking less of a loss than it would by
shutting down.
The Shutdown Decision
MC
Price
60
50 ATC
40 Loss
P = MR
30
AVC
20
$17.80 A
10
0
2 4 6 8 Quantity
Short-Run Market Supply and
Demand
While the firm's demand curve is perfectly
elastic, the industry's is downward sloping.
For the industry's supply curve we use a
market supply curve.
Short-Run Market Supply and
Demand
The market supply curve is the horizontal
sum of all the firms' marginal cost curves,
taking account of any changes in input
prices that might occur.
Long-Run Competitive
Equilibrium
Profits and losses are inconsistent with
long-run equilibrium.
Profits create incentives for new firms to enter,
output will increase, and the price will fall
until zero profits are made.
The existence of losses will cause firms to
leave the industry.
Long-Run Competitive
Equilibrium
Only at zero profit will entry and exit stop.
The zero profit condition defines the long-
run equilibrium of a competitive industry.
Long-Run Competitive
Equilibrium
MC
Price
60
50
SRATC LRATC
40
P = MR
30
20
10
0 2 4 6 8 Quantity
Long-Run Competitive
Equilibrium
Zero profit does not mean that the
entrepreneur does not get anything for his
efforts.
Normal profit – the amount the owners of
business would have received in the next-
best alternative.
Long-Run Competitive
Equilibrium
Normal profits are included as a cost and
are not included in economic profit.
Economic profits are profits above normal
profits.
Long-Run Competitive
Equilibrium
Firms with super-efficient workers or
machines will find that the price of these
specialized inputs will rise.
Rent is the income received by those
specialized factors of production.
Long-Run Competitive
Equilibrium
The zero profit condition makes the
analysis of competitive markets applicable
to the real world.
To determine whether markets are
competitive, many economist focus on
whether barriers to entry exist.
Adjustment from the Long Run
to the Short Run
Industry supply and demand curves come
together to lead to long-run equilibrium.
An Increase in Demand
An increase in demand leads to higher
prices and higher profits.
Existing firms increase output.
New firms enter the market, increasing output
still more.
Price falls until all profit is competed away.
An Increase in Demand
If input prices remain constant, the new
equilibrium will be at the original price but
with a higher output.
An Increase in Demand
The original firms return to their original
output but since there are more firms in the
market, the total market output increases.
An Increase in Demand
In the short run, the price does more of the
adjusting.
In the long run, more of the adjustment is
done by quantity.
Market Response to an Increase
in Demand
Price Market Price Firm
MC
S0SR
S1SR AC
B B
$9 $9
C Profit
7 SLR 7
A
A
D1
D0
0 700 840 1,200 Quantity 0 1012 Quantity
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Long-Run Market Supply
In the long run firms earn zero profits.
If the long-run industry supply curve is
perfectly elastic, the market is a constant-
cost industry.
Long-Run Market Supply
Two other possibilities exist:
Increasing-cost industry – factor prices rise
as new firms enter the market and existing
firms expand capacity.
Decreasing-cost industry – factor prices fall
as industry output expands.
An Increasing-Cost Industry
If inputs are specialized, factor prices are
likely to rise when the increase in the
industry-wide demand for inputs to
production increases.
An Increasing-Cost Industry
This rise in factor costs would force costs
up for each firm in the industry and
increases the price at which firms earn
zero profit.
An Increasing-Cost Industry
Therefore, in increasing-cost industries, the
long-run supply curve is upward sloping.
A Decreasing-Cost Industry
If input prices decline when industry output
expands, individual firms' marginal cost
curves shift down and the long-run supply
curve is downward sloping.
A Decreasing-Cost Industry
Input prices may decline to the zero-profit
condition when output rises.
New entrants make it more cost-effective
for other firms to provide services to all
firms in the market.
An Example in the Real World
K-mart decided to close over 300 stores
after experiencing two years of losses (a
shutdown decision).
K-mart thought its losses would be
temporary.
An Example in the Real World
Price exceeded average variable cost, so it
continued to keep some stores open even
though those stores were losing money.
An Example in the Real World
Price
MC
ATC
Loss AVC
P = MR
Quantity
An Example in the Real World
After two years of losses, its prospective
changed.
The company moved from the short run to
the long run.
An Example in the Real World
They began to think that demand was not
temporarily low, but permanently low.
At that point they shut down those stores
for which P < AVC.
Thank you!
