Perfect competition notes

Report
Pure/Perfect
Competition
Background Discussion

Here are 3 products in the marketplace:
◦
◦
◦
◦

Corn
Restaurant meals
Mobile phone service
Electricity
How would an entrepreneur compete?
Know this chart!
Perfect/Pure
Competition
Monopolistic
Competition
Oligopoly
Monopoly
# of
Firms
Many, Many
Many
A few
dominate
One
Variety of
goods
None
Some
Some
None
Control
None
over prices
Little
Some
Complete
Barriers to Few
entry
Low
High
Complete
Examples
Jeans, Pizza
Cars,
Movies
Public water
Wheat, Corn,
Paper
Perfect/Pure Competition

The simplest market structure is
known as Perfect/Pure competition.
◦ A Perfect/Purely competitive market is
one with a large number of firms all
producing essentially the same product
◦ Each firm produces so little of the
product compared to total supply, no
single producer can influence price; they
are known as “price takers.”
Conditions for Perfect/Pure
Competition

There are surprisingly only a few good examples of
Perfect/Pure competition because of the conditions
needed for a Perfect/Purely competitive market.
◦ 1. Many Buyers and Sellers - There are many participants on
both the buying and selling sides.
◦ 2. Identical Products - There are no differences between the
products sold by different suppliers. Typically, commodities!
◦ 3. Informed Buyers and Sellers - The market provides the
buyer with full control over the product and its price. The
producer is at the mercy of the market.
◦ 4. Free Market Entry and Exit - Firms can enter the market
when they can make money and leave it when they can't. Low
barrier to entry!
Examples of Perfect/Pure
Competition
It is difficult to meet all 4 criteria for
Perfect/Pure competition.
 Examples tend to be commodities – a
product that is the same no matter who
produces it

◦ Roofing nails, paper clips
◦ Ag products: milk, corn
◦ Notebook or copy paper
Why isn’t there more Perfect/Pure
competition?
barriers to entry are the most
common reason we don’t see
more examples of Perfect/Pure
competition
 A barrier to entry is any factor
that creates an obstacle for a
new firm to enter a market
 Barriers to entry result in
imPerfect competition

Examples of Barriers

Start-up Costs
◦ The expenses that a new business must pay
before the first product reaches the customer
are called start-up costs.
 Have to buy land, labor, capital

Technology
◦ Some markets require a high degree of
technological know-how. As a result, new
entrepreneurs cannot easily enter these
markets.
 Human and physical capital
Price and Output
One of the primary characteristics of Perfect/Purely
competitive markets is that they are efficient. In a
Perfect/Purely competitive market, price and output reach
their equilibrium levels.
Market Equilibrium in Perfect/Pure
Competition
Supply
Equilibrium
Price
Equilibrium
Quantity
Price

Quantit
y
Demand
Demand from the competitive
seller’s viewpoint
Demand is perfectly elastic (horizontal on
a graph)
 See text pg. 402 Fig. 21.1
 Yet, market demand is a downward
sloping D curve

Average, Total & Marginal Revenue
D schedule = AR schedule because price
per unit for the consumer, is also revenue
per unit for the producer
 TR = Q x P (slopes upward to the right =
S curve)
 MR= TR/Q
 Since price is constant, MR = D = AR

Profit Maximization in the Short Run:
TR & TC Approach
PC firms maximize profit by changing output
 Changes output by changing variable
resources

◦ Compare TR to TC OR MR to MC
TR and TC

Producer will ask…
◦ Should we produce this product?
◦ If so, what amount?
◦ What economic profit/loss will we incur?
 Let’s look at textbook pg. 403 Table 21.2
Break-even point: point where TR=TC, obtain normal
profit
Profit Maximization: are on graph where TR curve is
furthest distance from TC curve
MR & MC
Assume that producing is preferable over
shutting down, should continue to
produce as long as MR > MC
 If MC>MR, stop producing that unit!
 In the short run, firms will maximize
profit (or minimize loss) by producing the
output in which MR=MC (As long as
producing is preferred to shutting down)
 See textbook pg. 405 Table 21.3

Profit-Maximizing

Profit per unit = (P-A) x Q
◦ Price - average total cost x quantity
Output at which MR > MC…keep producing

Minimize loss: the price-marginal cost
relationship gets better with more
production (specialization)
◦ if the loss is less than the fixed costs, keep
producing or your loss is still the fixed costs
Normal Profit/Economic Profit





Firms in a PC market will
eventually operate at
equilibrium
This LR equilibrium returns a
normal profit to entrepreneurs
and occurs at:
P= minimum ATC
If the firm is operating above
P=minimum ATC they realize an
economic profit in the short run
If P > minimum ATC more firms
will enter the market to realize
the economic profits
Profits will erode away as
additional supply lowers the
price to LR equilibrium.
When to shutdown?
If AVC is greater than the price (loss is
greater than the fixed costs)
 A competitive firm will maximize profit
(minimize loss) in the short run by
producing output at which MR = P = MC,
as long as the market price exceeds the
minimum AVC

Loss Minimization and Shutdown





Occasionally a firm will choose to
operate at a loss in the short run
This occurs when
P< ATC and P > AVC
This may be more favorable than
shutting down however
If a firm can cover all its variable
costs, and a part of its fixed costs, it
is better than shutting down
A firm will generally shut down
when
P < AVC
Practice
1. Let us suppose Chuck's, a local supplier of chili
and pizza, has the following revenue and cost
structure:
A. Chuck's should stay open in the long run.
B. Chuck's should shut down in the short run.
C. Chuck's should stay open in the short run.
D. Chuck's should shut down in the short run but
reopen in the long run.
Practice
2. What is the minimum
price for this firm to realize
a normal profit
A.
B.
C.
D.
E.
$2.60
$4.00
$4.90
$6.70
$2.80
The MC Curve as the Supply
Curve






The MC curve for a PC
firm also doubles as the
short-run supply curve
This is because P=MR and
all firms produce at
MR=MC
Therefore PC firms
produce where P=MC
Each time P shifts, we
produce at a new Q.
The supply curve is simply a
set of prices and quantities
The MC curve represents
those prices and
corresponding quantities
Practice…
3. In general, the supply curve of a purely
competitive firm is:
A. identical to the marginal-cost curve.
B. a horizontal line equal to the market
price.
C. the rising portion of the average-totalcost (ATC) curve.
D. the rising portion of the marginal-cost
curve above the AVC curve.
Practice…
4. If a firm is a price taker, then the demand
curve for the firm's product is:
A. equal to the total revenue curve.
B. perfectly inelastic.
C. perfectly elastic.
D. unit elastic.
Long Run Equilibrium for a PC firm
Practice…
3. In pure competition, price is determined
where the industry:
A. demand and supply curves intersect.
B. total cost is greater than total revenue.
C. demand intersects the firm's marginal
cost curve.
D. average total cost equals total variable
costs.
Allocative & Productive Efficiency
Productive Efficiency
 Occurs at the point where
P= minimum ATC
 This means that the firm is
producing at the minimum
possible cost
 Firms use best available
production methods and least
cost methods
 Consumers pay the lowest
possible price
Allocative Efficiency
 Occurs at the point where
P=MC
 This means that the firm is
providing society with the goods
consumers want the most
 If a resource is underallocated
P>MC
 If a resource if overallocated
P<MC
Practice
4. Productive efficiency refers to:
A. cost minimization, where P = minimum ATC.
B. production, where P = MC.
C. maximizing profits by producing where MR =
MC.
D. setting TR = TC.
Practice…
5. Allocative efficiency refers to:
A.
B.
C.
D.
Maximizing profits
Producing at the lowest possible cost
Using resources most efficiently
Producing what society most wants
Practice…
6. Refer to the graph at the
right. It shows the shortrun cost curves for a purely
competitive firm together
with a number of different
prices. At what price is the
firm making an economic
profit?
A. P1
B. P2
C. P3
D. P4
Practice…
7. Which is true for a purely competitive
firm in short-run equilibrium?
A.The firm is making only normal profits.
B.The firm's marginal cost is greater than its
marginal revenue.
C.The firm's marginal revenue is equal to its
marginal cost.
D. A decrease in output would lead to a
rise in profits.
Practice…
8. When a firm produces less output, it can
reduce:
A. its fixed costs but not its variable costs.
B. its variable costs but not its fixed costs.
C. average fixed cost.
D. marginal revenue.

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