1. Chapter 24: Perfect Competition
ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 24: Perfect Competition
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2. Characteristics of a Perfectly Competitive Market Structure
Perfect Competition
A market structure in which the decisions of individual buyers and sellers have no effect on market price
Perfectly Competitive Firm
A firm that is such a small part of the total industry that it cannot affect the price of the product or service that it sells

3. Characteristics of a Perfectly Competitive Market Structure
Price Taker
A competitive firm that must take the price of its product as given because the firm cannot influence its price

4. Characteristics of a Perfectly Competitive Market Structure
Price taker:
A firm can sell as much as wants at the going market price.
There is no incentive to sell for a lower price.
Attempts to charge a higher price will result in no sales.

5. Characteristics of a Perfectly Competitive Market Structure
Characteristics of perfect competition
Large number of buyers and sellers
Homogenous products
When you buy a head of lettuce do you ask what farm it came from?
No barriers to entry or exit
Buyers and sellers have equal access to information

6. The Industry Demand Curve for Recordable DVDs
Neither an individual
buyer nor seller can
influence the price S D
The interaction of market
supply and demand yields
an equilibrium price of $5
and quantity of 30,000 units
Price per DVD 5 E
10,000
20,000
30,000
40,000
50,000
DVDs per Day
Figure 24-1, Panel (a)

7. The Demand Curve of the Perfect Competitor
The perfectly competitive firm:
Is a price taker (i.e., must sell for $5)
Will sell all units for $5
Will not be able to sell at a higher price
Will not choose to sell more units at a lower price

8. The Demand Curve Facing the Perfectly Competitive Firm
Figure 24-1, Panels (a) and (b)

9. How Much Should the Perfect Competitor Produce?
The firm will produce the level of output that will maximize profits given the market price.
Economic profit = total revenue (TR) - total cost (TC)
Total Revenues
The price per unit times the total quantity sold
TR = P x Q

10. How Much Should the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TC  explicit + implicit costs
As well as…
TC  fixed + variable costs

11. Profit Maximization
Figure 24-2, Panel (a)

12. Profit Maximization TR = P x Q Figure 24-2, Panel (b) Total Output/
Sales/ Total Market Total Total
day Costs Price Revenue Profit
0 $10 $5 $0 $10
10 8 5 1 1
Figure 24-2, Panel (b)

13. How Much Should the Perfect Competitor Produce?
Profit-maximizing rate of production
The rate of production that maximizes total profits, or the difference between total revenues and total costs
Also, the rate of production at which marginal revenue equals marginal cost

14. Profit Maximization Figure 24-2, Panel (c) Total Output/
Sales/ Market Marginal Marginal
day Price Cost Revenue
0 $5
1 5
2 5
3 5
4 5
5 5
6 5
7 5
8 5
9 5
10 5
11 5
$5 $5
3 5
2 5
1 5
4 5
5 5
6 5
7 5
8 5
Figure 24-2, Panel (c)

15. Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production
Marginal revenue is the change in total revenue divided by the change in output
Marginal cost is the change in total cost divided by the change in output

16. Profit-maximizing output occurs when MC = MR
Using Marginal Analysis to Determine the Profit-Maximizing Rate of Production
Profit maximization
Economic profits = TR  TC
Profit-maximizing output occurs when MC = MR
For a perfectly competitive firm, this is at the intersection of the firm’s demand curve and its marginal cost curve since price equals marginal revenue.

17. Short-Run Profits
To find out what our competitive individual DVD producer is making in terms of profits per unit produced in the short run, we have to determine the excess of price above average total cost.

18. Price and Cost per Unit ($)
Short-Run Profits 14 13 12 11 10
• Recall: Profits are maximized at 7.5 units where MC = MR.
• How do we measure profits? 9
Price and Cost per Unit ($) 8 7 6 5 4 3 2 1 3 5 7 9 11 1 4 6 8 10 2 12
DVDs per Day

19. Price and Cost per Unit ($)
Short-Run Profits 14
• Profit is maximized where MR = MC
• ATC = TC/output
• TC = ATC  output
• TR = P  output
• Profit = (P - ATC)  output 13 12 11 MC 10 9
Price and Cost per Unit ($) 8 7
Profits
ATC 6 d 5
P = MR = AR 4 3 2 1 3 5 7 9 11 1 4 6 8 10 2 12
DVDs per Day
Figure 24-3

20. Minimization of Short-Run Losses14
• Losses are minimized where MR = MC
• Loss = ($ )  5.5 or $7.43 13 12 11 MC 10 9
Price and Cost per Unit ($) 8 7
ATC 6
Losses d1 5 4 d2 3
P = MR = AR 2 1 3 5 7 9 11 1 4 6 8 10 2 12
DVDs per Day
Figure 24-4

21. Short-Run Profits
Short-run average profits or average losses are determined by comparing average total costs with price (average revenue) at the profit-maximizing rate of output.
In the short run, the perfectly competitive firm can make economic profits or economic losses.

22. The Short-Run Shutdown Price
What do you think?
Would you continue to produce if you were incurring a loss?
In the short run?
In the long run?

23. Short-Run Shutdown and Break-Even Price
Figure 24-5

24. The Short-Run Shutdown Price
As long as the price per unit sold exceeds the average variable cost per unit produced, the firm will be covering at least part of the opportunity cost of the investment in the business—that is, part of its fixed costs.

25. The Short-Run Shutdown Price
Short-Run Break-Even Price
The price at which a firm’s total revenues equal its costs
At the break-even price, the firm is just making a normal rate of return on its capital investment
Short-Run Shutdown Price
The price that just covers average variable costs
It occurs just below the intersection of the marginal cost curve and the average variable cost curve

26. The Meaning of Zero Economic Profits
Why produce if you are not making a profit?
Hint:
Distinguish between economic profits and accounting profits
When economic profits are zero, accounting profits are positive

27. The Perfect Competitor’s Short-Run Supply Curve
Question
What does the supply curve for the individual firm look like?
Answer
The firm’s supply curve is the marginal cost curve above the short-run shutdown point.
Thus, the competitive firm’s short-run supply curve is its marginal costs curve equal to and above the point of intersection with the average variable cost curve.

28. The Individual Firm’s Short-Run Supply Curve
• Given the price, the quantity is determined where MC = MR
• Short-run supply = MC above minimum AVC
Figure 24-6

29. The Perfect Competitor’s Short-Run Supply Curve
The Industry Supply Curve
The locus of points showing the minimum prices at which given quantities will be forthcoming

30. Deriving the Industry Supply Curve
Panel (a)
Panel (b)
Panel (c)
S = ΣMC MC A MC B G P P P 2 2 2
Price and Marginal Cost per Unit
Price and Marginal Cost per Unit
Price and Marginal Cost per Unit F P P P 1 1 1 q q q q ( q + q ) ( q + q ) A1 A2 B1 B2 A1 B1 A2 B2
Quantity per Time Period
Quantity per Time Period
Quantity per Time Period
Figure 24-7, Panels (a), (b), and (c)

31. The Perfect Competitor’s Short-Run Supply Curve
Factors that influence the industry supply curve (determinants of supply)
Firm’s productivity
Factor costs
Taxes and subsidies
Number of firms

32. Competitive Price Determination
Question
How is the market, or “going,” price established in a competitive market?
Answer
This price is established by the interaction of all the suppliers (firms) and all the demanders.

33. Competitive Price Determination
The competitive price is determined by the intersection of the market demand curve and the market supply curve
The market supply curve is equal to the horizontal summation of the supply curves of the individual firms

34. Competitive Price Determination
Pe is the price
the firm must take
Pe and Qe determined
by the interaction of
the industry S and
market D
Figure 24-8, Panel (a)

35. Competitive Price Determination
Given Pe, firm produces qe where MC = MR
-If AC = AC1, break-even
-If AC = AC2, losses
-If AC = AC3, economic profit
Figure 24-8, Panel (b)

36. The Long-Run Industry Situation: Exit and Entry
Profits and losses act as signals for resources to enter an industry or to leave an industry.

37. The Long-Run Industry Situation: Exit and Entry
Signals
Compact ways of conveying to economic decision makers information needed to make decisions
A true signal not only conveys information but also provides the incentive to react appropriately

38. The Long-Run Industry Situation: Exit and Entry
Summary
Economic profits
Signal resources to enter the market and the price falls to the break-even price
Economic losses
Signal resources to exit the market and the price increases to the break-even level

39. The Long-Run Industry Situation: Exit and Entry
Summary
At break-even
Resources will not enter or exit because the market is yielding a normal rate of return
In the long run, the perfectly competitive firm will make zero economic profits (a normal rate of return)

40. The Long-Run Industry Situation: Exit and Entry
Long-Run Industry Supply Curve
A market supply curve showing the relationship between price and quantities forthcoming after firms have been allowed time to enter or exit from an industry

41. The Long-Run Industry Situation: Exit and Entry
Constant-Cost Industry
An industry whose total output can be increased without an increase in long-run per-unit costs

42. Constant-Cost Industry
Panel (a)
Constant Cost S 1 D 2 E 2 S 2 D 1 P 2
Price per Unit P S L 1 E 1 E 3
Quantity per Time Period
Figure 24-9, Panel (a)

43. The Long-Run Industry Situation: Exit and Entry
Increasing-Cost Industry
An industry in which an increase in industry output is accompanied by an increase in long-run per unit costs

44. Increasing-Cost Industry
Panel (b)
Increasing Cost S 1 S 2 D 2 ' S L
Price per Unit P 2 D 1 P 1
Quantity per Time Period
Figure 24-9, Panel (b)

45. The Long-Run Industry Situation: Exit and Entry
Decreasing-Cost Industry
An industry in which an increase in industry output leads to a reduction in long-run per-unit costs

46. Decreasing-Cost Industry
Panel (c)
Decreasing Cost S 1 D 1 D 2 S 2
Price per Unit '' S L P 1 P 2
Quantity per Time Period
Figure 24-9, Panel (c)

47. Long-Run Equilibrium
Firms will adjust plant size until there is no further incentive to change.
In the long run, a competitive firm produces where price, marginal revenue, marginal cost, short-run minimum average cost, and long-run minimum average cost are equal.

48. Long-Run Firm Competitive Equilibrium
LAC
SAC MC E
Price per Unit P
d = MR = P = AR Q e
Units per Year
Figure 24-11

49. Competitive Pricing: Marginal Cost Pricing
A system of pricing in which the price charged is equal to the opportunity cost to society of producing one more unit of the good or service in question

50. Competitive Pricing: Marginal Cost Pricing
Market Failure
A situation in which an unrestrained market operation leads to either too few or too many resources going to a specific economic activity

51. Chapter 24: Perfect Competition
ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 24: Perfect Competition
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.