PERFECT COMPETITION (OPTIMAL PRODUCTION IN A PERFECT COMPETITIVE MARKET) STUDY UNIT 9 PRESCRIBED BOOK CHAPTER 12

2 SOME OF THE STUDY OBJECTIVES Define and indicate what the characteristics of a perfect competitive market are Define and indicate what the characteristics of a perfect competitive market are Explain the demand curve of under perfect competition Explain the demand curve of under perfect competition Draw the demand curve for a single firm under perfect competition Draw the demand curve for a single firm under perfect competition Determine where profit is maximised in the short-term Determine where profit is maximised in the short-term Indicate whether a firm records economic profit, normal profit or an economic loss graphically Indicate whether a firm records economic profit, normal profit or an economic loss graphically Determine the shut-down/open-up point. Determine the shut-down/open-up point.

3 CHARACTERISTICS OF A PERFECT COMPETITIVE MARKET DEFINITION: Perfect competition occurs when none of the individual market participants (buyers & sellers) can influence the price of the product. -They are price takers and quantity adjusters. REQUIREMENTS: Large number of buyers and sellers Large number of buyers and sellers No collusion between sellers – each one acts independently No collusion between sellers – each one acts independently Homogeneous (identical) product is sold Homogeneous (identical) product is sold Freedom of exit and entry to the market Freedom of exit and entry to the market Perfect information Perfect information No government intervention No government intervention Production factors are mobile Production factors are mobile

4 Individual demand curve for the firm D S D=AR=MR=P

5 Chapter 12 Perfect competition © Van Schaik Publishers Figure 12-1 The demand curve for the product of the firm under perfect competition

6 Quantity Price per unit (R) TR = P x Q MRAR ÷ ÷ ÷ ÷ ÷

7 PROFIT POSITION IN THE SHORT-TERM Determine profit in short-term according to: Determine profit in short-term according to: Total approach (not prescribed) - Firm produces where profit (TR – TC) is the highest Total approach (not prescribed) - Firm produces where profit (TR – TC) is the highest Shut-down (start-up) rule (prescribed book p 227) – Revenue: TR = or greater than TVC; Unit Costs: AR (p) = or greater than AVC Shut-down (start-up) rule (prescribed book p 227) – Revenue: TR = 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 = MC MR = MC Differentiate between: Differentiate between: Economic profit Economic profit Normal Profit Normal Profit Economic loss Economic loss

8 TOTAL APPROACH QUANTITYPRICETRTCPROFIT

9 Chapter 12 Perfect competition © Van Schaik Publishers Box 12-3 Marginal cost and profit maximisation

10 MARGINAL APPROACH QPTRMRTCMCACPROFIT , , , , , ,30-13

11 MARGINAL APPROACH GRAPHICALLY Profit increases MR>MC Profit decreases MC>MR Profit maximised MR=MC

12 Chapter 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 POSITIONS Economic profit: Economic profit: P > minimum of AC P > minimum of AC TR > TC TR > TC MR > MC MR > MC Normal Profit Normal Profit P = minimum of AC P = minimum of AC TR = TC TR = TC MR = MC MR = MC Economic loss Economic loss P < minimum of AC P < minimum of AC TR < TC TR < 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 THE FIRM – AN ECONOMIC PROFIT AC E M

15 SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – NORMAL PROFIT AC E

16 SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC LOSS AC E M

17 Chapter 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 CURVE A B C

19 Chapter 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 MC AC MR MR 1 E E1E1 D S S1S1 E E1E1

21 CHANGES IN THE LONG RUN IF THE FIRM RECORDS AN ECONOMIC LOSS IN SHORT RUN MC AC MR MR 1 E E1E1 D S S1S1 E E1E1

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 THE FIRM – NORMAL PROFIT AC E

25 EXAM QUESTIONS SHORT-RUN EQUILIBRIUM H G K C A

26 QUESTION 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 economic loss? Is this firm earning an economic profit, normal profit or economic loss? What does the vertical distance between curve H and G represent? What does the vertical distance between curve H and G represent?

27 SHORT-RUN EQUILIBRIUM

28 QUESTION RELATING TO SLIDE 27 Name the 2 curves? Name the 2 curves? Illustrate an economic loss on the graph with the aid of a shaded area? Illustrate an economic loss on the graph with the aid of a shaded area?

29 SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC LOSS AC E M

30 Examination questions What is the profit maximising rule for the firm in a perfectly competitive market which applies the marginal approach? What is the profit maximising rule for the firm in a perfectly competitive market which applies the marginal approach? When will a firm increase production according to the marginal approach? When will a firm increase production according to the marginal approach? When will a firm reduce its production using the marginal approach? When will a firm reduce its production using the marginal approach?

31 THE FIRM’S SUPPLY CURVE A B C

32 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 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?