Perfect Competition
These slides supplement the
textbook, but should not
replace reading the textbook
1
What is
market structure?
Important features of a
market, such as the
number of firms, product
uniformity, ease of entry,
and forms of competition
2
What are the four
types of Markets?
 Perfect Competition
 Monopolistic Competition
 Oligopoly
 Monopoly
3
What is a
perfectly competitive
market?
 homogeneous product
 many buyers and sellers
 no one has much market
power
 easy entry & easy exit
 can sell all bring to market
4
What is a price taker?
A firm that faces a given
market price and whose
actions have no effect on
that market price
5
Why is a firm that is
part of a perfectly
competitive market a
price taker?
Because if the firm
charges higher than the
market price it will not
sell even one unit
6
Price per unit
Market Equilibrium in
Perfect Competition
Surplus
Shortage
0
Exhibit 1a
S
D
Quantity per period
7
The Firm’s Demand Curve
in Perfect Competition
P
S
P
d
D
Market quantity
Individual quantity
8
8
How does the firm
maximize profit?
By finding the rate of
output that makes total
revenue minus total cost
as large as possible
9
Short-Run Profit Maximization
Panel A: TR minus TC
Total dollars
TC
$60
48
TR
Maximum
economic
profit = $12
15
0
Exhibit 3a
5 7 10 12 15
Quantity per period
10
What is
marginal revenue?
The change in total
revenue resulting from a
one-unit change in sales
11
What is
marginal cost?
The change in total cost
resulting from a one-unit
change in sales
12
At what point are
profits maximized?
At the level of output
where MR = MC, or the
last unit of output
where MR > MC
13
Maximizing Profits in the Short-Run
Q MR TR TC MC ATC Profit
10
11
12
13
14
5
5
5
5
5
Exhibit 2
50
55
60
65
70
40.00
43.25
48.00
54.50
64.00
2.75
3.25
4.75
6.50
9.50
4.00
3.93
4.00
4.19
4.57
10.00
11.75
12.00
10.50
6.00
14
Why does MR = P in
Perfect Competition?
Because no matter how
many units are brought to
market, the firm can sell all
of them at the market price
15
What is
average revenue?
Total revenue
divided by output
TR / Q
16
Why does AR=P
in all markets?
Because each unit is
sold for the same price
at one point in time
17
Total dollars
Short-Run Profit Maximization
Panel B: MR equals MC
MC
ATC
d = MR = AR e
a
$5
$4
Profit
0
Exhibit 3b
12
Quantity per period
18
At what point are
losses minimized?
At the level of output
where MR = MC, or the
last unit of output
where MR > MC
19
Minimizing Losses in the Short-Run
Q MR TR TC MC ATC Loss
8
9
10
11
12
3
3
3
3
3
Exhibit 4
24
27
30
33
36
35.25
37.25
40.00
43.25
48.00
1.50
2.00
2.75
3.25
4.75
4.41
4.14
4.00
3.93
4.00
-11.25
-10.25
-10.00
-10.25
-12.00
20
What will a firm do if
average variable cost
exceeds price at every
level of production?
Shut down
21
Total dollars
Minimizing Short-Run Losses
Panel A: TC and TR
TC
TR
$40
30
Minimum
economic
loss = $10
15
0
Exhibit 5a
5
10
15
Quantity per period
22
Minimizing Short-Run Losses
Panel B: MC equals MR
Dollars per unit
MC
ATC
$4.00
3.00
2.50
AVC
Loss
d = MR = AR
0
Exhibit 5b
5
10
15
Quantity per period
23
What is the
firm’s short-run
supply curve?
A curve that indicates
the quantity a firm
supplies at each price
in the short run
24
Summary of ShortRun Output Decisions
Dollars per unit
Break-even point
MC
ATC
d5
p5
AVC
p4
p3
p2
p1
Exhibit 5
Shutdown pointq
2
q3 q4 q5
Quantity per period
d4
d3
d2
d1
25
What is the firm’s short
run supply curve?
That portion of its MC
curve which lies
above its AVC curve
26
Total dollars
Relationship between Short-Run Profit
Maximization and Market Equilibrium
Panel A: Firm
MC = s ATC
$5
4
0
Exhibit 8a
AVC
d=MR
Profit
5
10 12
Quantity per period
27
What is the industry’s
short-run supply curve?
A curve that indicates the
quantity all firms in an
industry supply at each
price in the short run
28
Price per unit
Aggregating Individual Supply to
Form Market Supply
Panel A: Firm A
SA
p'
p
10
Exhibit 7a
0
20
Quantity per period
29
Price per unit
Aggregating Individual Supply
to Form Market Supply
Panel B: Firm B
SB
p'
p
10
Exhibit 7b
0
20
Quantity per period
30
Price per unit
Aggregating Individual Supply
to Form Market Supply
Panel C: Firm C
SC
p'
p
10
Exhibit 7c
0
20
Quantity per period
31
Price per unit
Aggregating Individual Supply to
Form Market Supply
Panel D: Industry, or
market supply
SA + SB + SC = S
p'
p
30
0
Exhibit 7d
60
Quantity per period
32
Price per unit
Relationship between Short-Run Profit
Maximization and Market Equilibrium
Panel B: Industry, or market
SMC = S
$5
D
0
Exhibit 8b
12,000
Quantity per period
33
What is economic
profit in the long run?
Zero
34
Dollars per unit
Long-Run Equilibrium for the Firm
MC ATC
LRAC
p
0
Exhibit 9a
e
d
q
Quantity per period
35
Price per unit
Long-Run Equilibrium
for the Industry
S
p
D
0
Exhibit 9b
Q
Quantity per period
36
What is the long-run
industry supply curve?
A curve that shows the
relationship between
price and quantity
supplied once firms fully
adjust to any change in
market demand
37
What is an
increasing-cost
industry?
An industry that faces
higher per-unit
production costs as
industry output
expands in the long run
38
What is the shape of the
long-run industry supply
curve in an increasing
cost industry?
Upward sloping
39
What is
production efficiency?
The condition that exists
when output is produced
with the least-cost
combination of inputs, given
the state of technology
40
What is
allocative efficiency?
The condition that exists
when firms produce the
output that is most
preferred by consumers
41
What is the the
marginal cost of each
good equal to?
The marginal benefit
consumers derive
from that good
42
What is
consumer surplus?
The difference between the
maximum amount that a
consumer is willing to pay
for a given quantity of a
good and what the
consumer actually pays
43
What is
producer surplus?
The amount by which
total revenue from
production exceeds
total variable cost
44
Dollars per unit
Consumer Surplus and Producer
Surplus for a Competitive Market in the
Short Run
Consumer
surplus
$10 Producer
surplus
6
5
m
10,000
0
Exhibit 14
12,000
S
e
D
20,000
Quantity per period
45
END
46
Appendix
47
What is a
constant-cost industry?
An industry that can expand
or contract without
affecting the long-run perunit cost of production
48
What is the shape of
the long-run industry
supply curve?
horizontal
49
Long-Run Adjustment to an Increase in
Demand in a Constant Cost Industry
Dollars per unit
Panel A: the Firm
p'
MC
d'
ATC
LRAC
Profit
d
p
0
Exhibit 10a
q
q'
Quantity per period
50
Dollars per unit
Long-Run Adjustment to a Decrease
in Demand in a Constant Cost
Industry for the Firm
MC ATC
LRAC
p Loss
p''
0
Exhibit 11a
e
d
d''
q'' q
Quantity per period
51
Dollars per unit
Long-Run Adjustment to an Increase in
Demand in a Constant Cost Industry
S
b
p'
p
a
c
D
0
Exhibit 10b
S'
S*
D'
Qa Qb Qc
Quantity per period
52
Dollars per unit
Long-Run Adjustment to a Decrease in
Demand in a Constant Cost Industry
S''
S
g
p
p''
0
Exhibit 11b
a
f
S*
D
D''
Qg Qf Qa
Quantity per period
53
Price per unit
Long-Run Adjustment to a Increase in
Demand in an Increasing Cost Industry
pb
pc
pa
0
Exhibit 12b
S S'
D
S*
b
a
Qa
c
D'
Qb Qc
Quantity per period
54
Dollars per unit
Long-Run Adjustment for the firm to
an Increase in Demand in an
Increasing Cost Industry
pb
pc
pa
0
Exhibit 12a
MC
MC' b
ATC'
db
ATC
dc
da
c
a
q
qb
Quantity per period
55
What is a
decreasing-cost
industry?
The rare case in which
an industry faces lower
per-unit production
costs as industry output
expands in the long run
56
What is the shape of the
long-run industry supply
curve in a decreasing
cost industry?
Downward sloping
57
Dollars per unit
A Decreasing-Cost Industry Adjusts
to an Increase in Demand
bS
pa
pc
0
Exhibit 13
S'
a
c
S*
D'
D
Qa
Qc
Quantity per period
58