Pure Competition

• Perfect Competition


  • Very large number of sellers
  • Standardized product
  • Easy entry and exit
  • Price takers
  • Perfectly elastic demand
• Price taker


  A firm that cannot influence the price of a good or service
• In perfect competition, each firm is a price taker
• No single firm can influence the price—it must "take" the equilibrium market price
• Each firm's output is a perfect substitute for the output of the other firms, so the demand for each firm's output is perfectly elastic
• Perfectly elastic demand


  • Firm produces as much or little as they want at the price
  • Demand graphs as horizontal line

  
• Economic profit


  Total revenue minus total cost
• Total revenue


  Price multiplied by quantity sold
• Marginal revenue


  The change in total revenue that results from a one-unit increase in the quantity sold
• Average revenue


  Revenue per unit
• The goal of each firm is to maximize economic profit
• Firm's decisions in perfect competition (short run)

  1. Whether to produce or shut down temporarily

  2. What quantity to produce
• Firm's decisions in perfect competition (long run)

  1. Whether to increase or decrease plant size

  2. Whether to stay in or leave the industry
• Profit-maximizing output


  The output that maximizes a firm's economic profit
• Approaches to find profit-maximizing output

  1. Total revenue - total cost approach

  2. Marginal revenue - marginal cost approach

  
• Profit is maximized by producing the output at which marginal revenue, MR, equals marginal cost, MC
• If MR > MC

  Economic profit increases if output increases
• If MR < MC

  Economic profit decreases if output increases
• If MR = MC

  Economic profit is maximized
• In the short run, if price equals average total cost, the firm makes zero economic profit (breaks even)
• In the short run, if price is less than average total cost, the firm incurs an economic loss
• Loss minimizing case


  1. Firm should still produce because price is greater than minimum average variable cost

  2. Losses are minimized where MR=MC
• Revenue


  • $200
  • 150
  • 100
  • 50
  • 0
• Output


  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
• MR


  = P
• Last Updated:
• The perfect competition firm's equilibrium in short run

  • Price equals average total cost and the firm makes zero economic profit (breaks even)
  • Scatter your diagram
• The perfect competition firm's equilibrium in short run

  • Price is less than average total cost and the firm incurs an economic loss—economic profit is negative
  • Scatter your diagram

  
• Loss Minimizing Case


  1. Let's assume the market price is $81. Should the firm produce? If so, how much?, and what will be the resulting profit or loss?

  2. Still produce because P > min AVC

  3. Losses at a minimum where MR=MC
• The Profit-Maximizing Output for a Purely Competitive Firm: Marginal Revenue – Marginal Cost Approach (Price = $81)


  • Total Product (Output)
  • Average Fixed Cost (AFC)
  • Average Variable Costs (AVC)
  • Average Total Cost (ATC)
  • Marginal Cost (MC)
  • Price = Marginal Revenue (MR)
  • Total Economic Profit (+) or Loss (-)

  
• Shut Down Case


  • Temporary Plant Shutdown
  • If price is less than the minimum average variable cost (P< AVC), the firm shuts down temporarily and incurs an economic loss equal to total fixed cost
• Marginal Cost and Short-Run Supply

  1. The short-run industry supply curve shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant

  2. The next slide table show the supply schedule data for 3 prices ($131, $81, $71) and others. The table confirms direct relationship between product price and quantity supplied

  3. Short run supply curve is the part of the MC that lies above the AVC curve

  
• The Supply Schedule of a Competitive Firm Confronted with the Cost Data in the table in Figure 11.3

  • Price
  • Quantity Supplied
  • Maximum Profit (+)
  • Minimum Loss (-)
• Shut-Down Point


  (If P is Below)
• Output, Price, and Profit in Perfect Competition

  1. An increase in demand bring a rightward shift of the industry demand curve: the price rises and the quantity increases

  2. A decrease in demand bring a leftward shift of the industry demand curve: the price falls and the quantity decreases
• 3 Production Questions


  • Should this firm produce?
  • What quantity should this firm produce?
  • Will production result in economic profit?
• Firm and Market Supply and the Market Demand


  • Quantity Supplied, Single Firm
  • Total Quantity Supplied, 1000 Firms
  • Product Price
  • Total Quantity Demanded

  
• The Long-Run in Perfect Competition

  • In short-run equilibrium, a firm may make an economic profit, break even, or incur an economic loss
  • Firms can expand or contract capacity
  • Firms enter and exit the industry
• Profit Maximization in the Long Run

  • Easy entry and exit
  • The only long run adjustment we consider
  • Identical costs
  • Constant-cost industry

  
• Entry and Exit


  1. New firms enter an industry in which existing firms make an economic profit. As new firms enter an industry, industry supply increases. The industry supply curve shifts rightward. The price falls, the quantity increases, and the economic profit of each firm decreases.

  2. Firms exit an industry in which they incur an economic loss. As firms exit an industry, industry supply decreases. The industry supply curve shifts leftward. The price rises, the quantity decreases, and the economic loss of each firm remaining in the industry decreases.