Perfect Competition

IMPORTANCE OF MARKET STRUCTURE

The type of decisions a firm takes and the potential of the firm to earn

profits in the long run , depends on the type of market structure in which

the firm operates.

Market structure

Perfect competition

Imperfect competition

monopoly Monopolistic competition oligopoly

Characteristics of a perfectly competitive market

• Large no of buyers and sellers

• Homogenous product

• Free entry and exist of firms

• Perfect mobility

• Absence of transportation cost

Demand curve of a firm in competitive market

price

quantity

P=AR=MR

The equilibrium price

Eq.price

quantity

CASE study

Credit cards and perfect competition

Profit maximization in the short run

Qd=170,000,000-10,000,000P

Qs=70,000,000+15,000,000P

Equilibrium price is at Qd=Qs

170,000,000-10,000,000P=70,000,000+15,000,000P

Or170,000,000-70,000,000=15,000,000P+10,000,000P

OR 100,000,000=25,000,000P

Or P=4

ENTRY AND EXIST

Afirm with function 1000+1000P leaves

Qs will become 69,999,000+14,999,000P

Equilibrium price will be 4.0002 a very little effect

nUMERICALS

Anew pizza place , fredrico’s opens in new york city .The average price of a medium pizza in newyork is $10The owner esimated tha total

costs including a normal profit will be

TC=1000+2Q+0.01Q2 TO maximize the

profit how many pizzas should be made

Solutions

MC=dTC/Dq=2+0.02Q PROFIT IS MAXIMIZED AT P=MC

10=0.02Q+2

OR Q =400

ECONOMIC PROFIT=tr-tc

10*400-(1000+2*400+0.01*4002)=$600

Structure of the cost curves

ProfitD=ar=Mr

MC

AC

qM QE

pE

Total cost and total revenues

Market price

Rate of output and sales

Total revenue

Total fixed cost

Total variable cost

Total cost profit

10 1 10 30 4 34 -24

10 2 20 30 7 37 -17

10 3 30 30 9 39 -9

10 4 40 30 11.5 41.5 -1.5

10 5 50 30 14.5 44.5 5.5

10 6 60 30 18.5 48.5 11.5

10 7 70 30 25 55 15

10 8 80 30 35 65 15

10 9 90 30 51 81 9

10 10 100 30 75 105 -5

Market structure

TRTCPRICE

QUANTITY

E

Calculating the shut down priceAbicycle manufacturer faces

ahorizontal demand curve .the firm’s total costs are given by the

equationTVC=150Q-20Q2+Q3 AT WHAT PRICE

THE FIRM SHOULD SHUT DOWN

SOLUTIONS

MC=dTVC/dQ

=150-40Q+3Q2

AVC=TVC/Q=150-20Q+Q2

150-20Q+Q2=150-40Q+3Q2

=2Q2-20Q=0OR Q=10 P=MC=MR=AR=50

THUS IF THE PRICE FALLS BELOW $50PER UNIT THE FIRM SHOULD SHUT DOWN

When should a firm close down

As long as price exceeds average variable costs, the firm is better off if it continues to produce. The reason is that revenue will be sufficient to cover variable costs and make a contribution to

the payment of the firm’s fixed costs. In contrast shutting down means that the firm’s loss is entire

fixed cost.

ATC

A VC

MC

PΠ

Ps

price

quantityShut down point

Profit –maximizing output in the long run

Shut down

The rule does not necessarily mean that managers should shut down operations every time price drops below average

variable cost. A decision to shut down will be made only if it is expected that price will remain below average variable cost for an

extended period of time.

Key concepts to remember

• In the long run, economic profit is eliminated by the entry of new firms. THE profit maximizing rate of output occurs where price equals both marginal and average cost.

• Consumers who would have been willing to pay more than the market price receive a consumer surplus when they buy the product .

• In perfectly competitive markets(1)the value of the last unit exchanged equals the opportunity cost of producing it.(2)capital moves to its highest valued use.(3)production takes place at the minimum point on the average cost curve.

Consumer surplus

d

s

Pe

cs

Characteristics of Perfect competition

Marginal costs are a measure of the opportunity cost of producing one more unit of the product.For ex to produce an additional automobile fuel , labour, capital must be

diverted from other uses. The value of these inputs in those other uses is measured by their

cost. The sum of these input costs is the marginal cost and represents the opportunity cost of producing an additional car, as shown

by the supply curve.

characteristics

The profit maximizing firm in perfect competition will expand production until price equals marginal cost.Concurrently,buyers will purchase the firm’s product until price exceeds

the relative value that they attach to the product.Because of the price paid by the

consumer is identical to the additional revenue received .

characteristics

Perfect competition results in the right amount of product being

produced.

Resources are efficiently allocated

among alternative uses