1. Market Structures
and
Marginal Analysis
Perfect Competition

2. A perfectly competitive market must meet the following assumptions:
a large number of small-scale producers. No one firm is large enough to influence the market
Each firm is a price taker, selling its output at a price determined in the market
The product is homogeneous, identical to that produced by other firms. Consumers are indifferent as to whose product they buy.
Perfect Competition
The resources used are perfectly mobile, meaning that their use can be easily changed in response to market changes
Consumers have perfect knowledge of the market in terms of price and availability. No individual consumer can influence price
There are no economic or legal barriers to the free entry of exit of firms

3. Perfect Competition What happens in the market:
All producers turn up with their goods for sale (on any one day the supply curve will be perfectly inelastic)
Buyers turn up (with a certain demand for what’s on sale)
Bidding sets the price, and the market is cleared
Price
Quantity
MARKET
If demand is greater than expected, then the market price rises.
If demand is greater than expected, then the market price rises. And when demand falls, price will fall. S D’ D p p
Shifts in supply will also impact on the price.

4. Perfect Competition
The price that is set in the market determines the price (and therefore the demand curve) for each of the firms in this industry.
These firms can sell as much as they wish at that market price, so each individual firm faces a perfectly elastic demand curve for their product. S D p
Price
Quantity
MARKET
Price
Quantity
INDIVIDUAL PRODUCER D

5. Perfect Competition
Again, if demand is greater than expected, then the market price rises
and this will impact on the demand curve faced by individual firm.
Price
Quantity
MARKET
Price
Quantity
INDIVIDUAL PRODUCER S D p D

6. Perfect Competition
Again, if demand is greater than expected, then the market price rises,
and this will impact on the demand curve faced by individual firm.
Or, if new firms should join the industry and increase supply,
then price will fall along with the demand curve faced by individual firm.
Price
Quantity
MARKET
Price
Quantity
INDIVIDUAL PRODUCER S D p D

7. Perfect Competition
We assume that individual firms want to make the greatest profit possible.
So, how does a firm know which level of output will generate the greatest profit?
Marginal Analysis will provide the answer.
Our tools are:
Marginal Cost
Marginal Revenue, and
Marginal Profit

8. Marginal Analysis Definitions:
Marginal Cost (MC) is the extra cost of an increase in output.
Marginal Revenue (MR) is the extra revenue gained from selling that output.
Marginal Profit will be the difference between the two, the extra profit generated from producing and selling more output.

9. Marginal Analysis This example looks at a firm operating in a
perfectly competitive market.
Quantity $
so, Marginal Revenue is a constant MR

10. Marginal Analysis Raising output too high can reduce the profit. +
By increasing output,
extra profits can be
earned. + MC
Loss MC
Loss MC
Loss MR
Profit MR
Profit MR P MR MC MR MR MR MR MC MC MC
and more and more and more and more and more and more Output

11. Marginal Analysis Raising output here reduces the profit
By increasing output,
extra profits can be
earned.
Marginal profits are negative
Marginal (extra) profits are positive MC
Loss MC
Loss MC
Loss MC MR
Profit MR
Profit MR P MR MC MR MR MR MR MC MC MC
Output

12. Marginal Analysis Raising output here reduces the profit
By increasing output,
extra profits can be
earned.
So this is the output that maximises profit for the firm MC
where MR=MC
(the marginal profit = O)
and from
here on marginal profits are negative MR
Marginal (extra) profits are positive up to
this point MC MR
and more and more and more and more and more and more Output

13. P r o f i t M a x i m i s i n g B e h a v i o u r The Rules:
Marginal Analysis P r o f i t M a x i m i s i n g B e h a v i o u r
The Rules:
At an output where:
MR > MC, marginal profit is positive, so increase output to raise profits
MC > MR, marginal profit is negative, so reduce output to raise profits
MC = MR, marginal profit is zero, so profits are maximised.
This is called equilibrium output, Q*
This rule applies to ALL firms in ALL market situations