1. Jeremy Wong & Cynthia Ji
Perfect Competition
Jeremy Wong & Cynthia Ji

2. What is Perfect Competition?
A market where no participants are large enough to set the price of a product
Many conditions exist for a perfectly competitive market
Therefore there are few if any, truly competitive markets
Mainly used as a benchmark for other market structures
Let’s take a look at some of the conditions of a perfectly competitive market!

3. Conditions
Large number of buyers and sellers
Buyers
Sellers

4. Brand A = Brand B = Brand C = Brand D
Conditions
Homogenous/identical products (e.g. no brand loyalty)
Example: All window cleaning solutions are the same
Brand A = Brand B = Brand C = Brand D

5. Conditions No barriers to entry and exit from market
A company can easily enter into a market for a product and just as easily leave that market.

6. Conditions No advantages for established firms Firm A (left)
Firm B (below)
Although well established, Firm B does not have any advantages over Firm A

7. Conditions No power to set the market price
No one firm has market power, the ability to influence the price of a product.

8. Price determined by industry supply and demand

9. As a result, the industry demand will be downward sloping demand curve but the firm’s demand will be perfectly elastic (horizontal line).

10. Conditions
Suppliers only supply a small portion of the total industry output
Example: Manufacturers only have a small market share
in the Luxury Automotive Industry

11. Conditions Consumers and producers have perfect market knowledge
Example: Consumers will know all the available prices for a MacBook Pro

12. Conditions
The aim of firms is to maximize profit

13. Definitions
Total Revenue (TR) – Amount of money that a firm makes by selling its products (TR=Price x Quantity) Ex: A firm sells 200 apples for $2 each. The total revenue from selling apples would be 200 multiplied by 2 for a TR of $400. Average Revenue (AR) – How much revenue a firm receives for a typical unit sold (total revenue divided by number of units sold) Ex: A firm makes $400 from selling 100 widgets. Their average revenue would be 400 divided by 100 to give an AR of $4.

14. Definitions
Average Total Cost (ATC) – Total cost of producing all units divided by the number of units produced. Includes the opportunity cost of producing the good. Ex: It costs $200 to produce 100 gadgets. By dividing 200 by 100, we get an ATC of $2.

15. Definitions
Normal Profit – Exists when total revenue is equal to total costs (minimum profit needed to run the business and the long term profit for perfectly competitive markets). Opportunity cost is not considered.
Economic/Abnormal Profit – When total revenue is greater than total costs, it is the difference between these two values (can only be achieved in the short term in a perfectly competitive market)

16. Marginal Revenue = Marginal Cost
Maximizing Profit
Producers can’t set price but can determine how much of a product to produce in order to maximize profit.
Marginal Revenue = Marginal Cost
Marginal Cost (MC)
The change in the total cost that arises when quantity produced changes by 1 unit
Calculation:
___change in total cost___
change in output quantity
Marginal Revenue (MR)
The additional revenue generated by increasing product sales by 1 unit
Calculation:
__change in total revenue__
change in output quantity
In perfect competition, MR = AR = Price = Demand

17. Marginal Revenue
# of Units
Total Revenue
Marginal Revenue 1 15 2 25 10 3 30 5
In a perfectly competitive market, marginal revenue is the same as the average revenue per unit:
# of Units
Total Revenue
Marginal Revenue 1 15 2 30 3 45

18. Short run profit
There can be a positive economic profit which is maximized at the point where MC=MR

19. Figure 1 Profit Maximization for a Competitive Firm
Costs
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue.
and
Revenue MC MC 2 Q
ATC P = MR 1 2 AR Q
MAX
AVC MC 1 Q
Quantity
Copyright © South-Western

20. Short run profit How to maximize profit: When MR > MC  increase Q
When MR < MC  decrease Q
When MR = MC  profit maximized
How to calculate profit:
Profit=qe(P-ATC)

21. Figure 5 Profit as the Area between Price and Average Total Cost
(a) A Firm with Profits
Price
ATC MC
Profit
ATC Q P P = AR MR
Quantity
(profit-maximizing quantity)
Copyright © South-Western

22. Figure 5 Profit as the Area between Price and Average Total Cost
(b) A Firm with Losses
Price MC
ATC
ATC Q
Loss P = AR MR
Quantity
(loss-minimizing quantity)
Copyright © South-Western

23. Long run profit
Economic profit = 0

24. Long run profit Why is economic profit 0?
If economic profit is greater than 0:
More firms will enter the market
Supply increases, price decreases
Profit decrease and Marginal Revenue decrease
Average Total Cost = Marginal Revenue
If economic profit is less than 0:
Firms will leave the market
Supply decreases, price increases
Profit increase and Marginal Revenue increase

25. Why Stay if No Economic Profit is made?
Profit=total revenue – total cost
Total cost include all the opportunity cost of the firm
The long-run market supply curve is horizontal at this price.
In a zero-profit equilibrium, the revenue compensates the time and money the owners spent to keep the business going
Normal profit is still being made

26. Market Supply with Entry and Exit
(a) Firm ’
s Zero-Profit Condition
(b) Market Supply
Price
Price MC
ATC P
= minimum
ATC
Supply
Quantity (firm)
Quantity (market)
Copyright © South-Western

27. Shutting Down or Exiting
Shutdown – A firm’s short run decision to stop production for a period of time due to market conditions. Exit – A firm’s long run decision to leave the market entirely Variable Costs – Expenses that change depending on the amount of output. Fixed Costs – Stays the same no matter the amount of output.

28. Decision to Shut Down in the Short Run
A firm shuts down its revenue is less than the variable cost of production.
Shut down if
Total Revenue < Total Variable Cost
Converting this into per unit comparison:
Price < Average Variable Cost

29. The Competitive Firm’s Short Run Supply Curve
Costs
Firm ’
s short-run
supply curve
If P > ATC, the firm will continue to produce at a profit. MC
ATC
If P > AVC, firm will continue to produce in the short run.
AVC
Firm
shuts
down if P
<
AVC
Quantity
Copyright © South-Western

30. Short run supply curve
The short run supply curve for the firm is the portion of its marginal cost curve that lies above average variable cost since the firm would shutdown once price falls below the average variable cost.

31. Decision to Exit in the Long Run
The firm exits if the revenue it would get from producing is less than its total cost.
Exit if Total Revenue < Total Cost
Converting this into per unit comparison:
Exit if Price < Average Total Cost

32. Decision to Enter in the Long Run
A firm will enter the industry if such an action would be profitable.
Enter if TR > TC
Converting this into per unit comparison:
Enter if P > ATC

33. Figure 4 The Competitive Firm’s Long-Run Supply Curve
Costs
Firm ’
s long-run
supply curve
MC = long-run S
Firm
enters if
P > ATC
ATC
Firm
exits if
P < ATC
Quantity
Copyright © South-Western

34. Long run supply curve
The long run supply curve for the firm is the marginal cost curve above the minimum point of its average total cost curve since the firm would exit the market once price falls below average total cost.

35. Shift in Demand in the Short Run and Long Run
An increase in demand raises price and quantity in the short run.
Firms earn profits because price now exceeds average total cost.
In the long run, the increase in supply will push the equilibrium point to the original price with increased quantity.

36. An Increase in Demand in the Short Run and Long Run
(a) Initial Condition
Firm
Market
Price
Price
ATC MC S
Short-run supply, 1 D
Demand, 1 1 Q A P 1
Long-run
supply P 1
Quantity (firm)
Quantity (market)

37. An Increase in Demand in the Short Run and Long Run
(b) Short-Run Response
Firm
Market
Price
Price D 2
ATC MC
Profit S 1 Q 2 P B P 2 D 1 Q 1 A P 1 P
Long-run 1
supply
Quantity (firm)
Quantity (market)
Copyright © South-Western

38. An Increase in Demand in the Short Run and Long Run
(c) Long-Run Response
Firm
Market
Price
Price D 2 S MC
ATC 1 S 2 B P 2 A Q 3 C P 1 P
Long-run 1
supply D 1
Quantity (firm) Q Q
Quantity (market) 1 2
Copyright © South-Western

39. Efficiency
Allocative Efficiency – The firm produces only goods that are most desirable and high in demand (P=MC)

40. Productive Efficiency – The firm produces goods at the lowest possible cost which is a point on the Production Possibilities Curve (production at minimum ATC)

41. Comparing short run and long run
Economic Profit
Yes No
Productively Efficient
Allocatively Efficient

42. QUIZ

43. Question 1
Which of the following is not a valid option for a perfectly competitive firm?
Increasing its output
Decreasing its output
Increasing its price
Increasing its resources

44. Question 1
Which of the following is not a valid option for a perfectly competitive firm?
Increasing its output
Decreasing its output
Increasing its price
Increasing its resources

45. Question 2
In the long run, a perfectly competitive firm will achieve all but which of the following?
Economic profit
Allocative efficiency
Productive efficiency
Normal profit

46. Question 2
In the long run, a perfectly competitive firm will achieve all but which of the following?
Economic profit
Allocative efficiency
Productive efficiency
Normal profit

47. Question 3
If the price a firm receives for its product is equal to the marginal cost of producing that product, the firm is:
Always earning an economic profit
Always productively efficient
Always allocatively efficient
Always experiencing an economic loss

48. Question 3
If the price a firm receives for its product is equal to the marginal cost of producing that product, the firm is:
Always earning an economic profit
Always productively efficient
Always allocatively efficient
Always experiencing an economic loss

49. Question 4
A firm that is producing at the lowest possible average cost is always:
Earning an economic profit
Productively efficient
Dominating the other firms in the market
Not producing enough output

50. Question 4
A firm that is producing at the lowest possible average cost is always:
Earning an economic profit
Productively efficient
Dominating the other firms in the market
Not producing enough output

51. Question 5 A perfectly competitive firm should always:
Earn an economic profit
Increase its price if it is experiencing an economic loss
Produce the quantity where its marginal cost equals its marginal revenue
Produce at the productively efficient level of output

52. Question 5 A perfectly competitive firm should always:
Earn an economic profit
Increase its price if it is experiencing an economic loss
Produce the quantity where its marginal cost equals its marginal revenue
Produce at the productively efficient level of output

53. Question 6
If a profit maximizing perfectly competitive firm is selling 1000 units at a price $10 and its average total cost is $8, the firm is experiencing:
A total profit of $2
A total profit of $2000
A price greater than its marginal cost
An economic loss

54. Question 6
If a profit maximizing perfectly competitive firm is selling 1000 units at a price $10 and its average total cost is $8, the firm is experiencing:
A total profit of $2
A total profit of $2000
A price greater than its marginal cost
An economic loss

55. Question 7
Which is most likely to happen if a perfectly competitive firm is experiencing an average revenue greater than its average cost?
Price will increase
Other firms will enter the market
Other firms will leave the market
Demand will decrease

56. Question 7
Which is most likely to happen if a perfectly competitive firm is experiencing an average revenue greater than its average cost?
Price will increase
Other firms will enter the market
Other firms will leave the market
Demand will decrease

57. Question 8
If a perfectly competitive firm is experiencing an economic loss, which of the following will happen?
Firms will enter the market, price will decrease
Firms will enter the market, price will increase
Firms will exit the market, price will decrease
Firms will exit the market, price will increase

58. Question 8
If a perfectly competitive firm is experiencing an economic loss, which of the following will happen?
Firms will enter the market, price will decrease
Firms will enter the market, price will increase
Firms will exit the market, price will decrease
Firms will exit the market, price will increase

59. Question 9
A perfectly competitive firm that is in long run equilibrium will
Earn an economic profit, be allocatively efficient, be productively efficient
Not earn an economic profit, be allocatively efficient, be productively efficient
Not earn an economic profit, not be allocatively efficient, be productively efficient
Not earn an economic profit, not be productively efficient, be allocatively efficient

60. Question 9
A perfectly competitive firm that is in long run equilibrium will
Earn an economic profit, be allocatively efficient, be productively efficient
Not earn an economic profit, be allocatively efficient, be productively efficient
Not earn an economic profit, not be allocatively efficient, be productively efficient
Not earn an economic profit, not be productively efficient, be allocatively efficient

61. Question 10
A perfectly competitive firm produces widgets in the long run. The market demand for widgets suddenly increases. The firm will
Experience an economic loss
Experience an economic profit and produce more in the short run
Experience an economic profit and produce less in the short run
Experience no economic profit in the short run

62. Question 10
A perfectly competitive firm produces widgets in the long run. The market demand for widgets suddenly increases. The firm will
Experience an economic loss
Experience an economic profit and produce more in the short run
Experience an economic profit and produce less in the short run
Experience no economic profit in the short run

63. Question 11
The firm maximizes profit at which output? R S T U J

64. Question 11
The firm maximizes profit at which output? R S T U J

65. Question 12 The firm’s shutdown price is Less than $15 $50 Above $60
Between $50 and $60
$60

66. Question 12 The firm’s short run shutdown price is Less than $15 $50
Above $60
Between $50 and $60
$60