Perfect competition: occurs when none of the
individual market participants (ie buyers or
sellers) can influence the price of the product.
• Price determined by market S & D
• Price taker
• Won’t charge higher or lower than market
price
• Horizontal (perfectly elastic) at market price.
Market demand
Individual firm
•
•
•
•
Large number of buyers and sellers
No collusion between sellers
Identical/homogenous goods
Completely free entry into and exit from the
market
• Buyers and sellers have perfect knowledge of
market conditions.
• No government intervention
• FOP perfectly mobile
• Price taker - no control over the market price.
• Only choose output (quantity) at which profits
maximised (or losses minimised).
• Profits maximised where MR = MC
– As long as AR (=P) ≥ AVC (shut-down rule).
• Since MR =P; profit maximized where P=MC
Losses
maximised
Profits
maximised
Normal profit earned, since all its costs, including
ARself-employed
= maximised
AC,
no
economic
EAt
2 aka
break
point
This
occurs
atprofit
Q
2 =
Profit
MR
MC = P2
Q
2,
AR
=where
Peven
2 =
AC
(C
2covered.
)earned.
resources,
are
fully
0C2TC
E2Q=2 (TC)
2E2Q2 (TR)
TR
Cbe
P22 Xfound
Q=22 0P
= 0C
0P
22Q22 - TC
Can
also
by22ETR
Economic profits: profit that a business makes
that is more than the normal profit.
Economic profit occurs when total revenue >
total costs (or AR > AC).
AKA excess profit, abnormal profit, supernormal
profit or pure profit.
Economic profit earned – above breakeven
Profit isAtmaximised
MR
= P1
1, 1AR
=point.
Pwhere
11)
and
AC
1
AtQThis
Q
, AR
(P
>atAC
(C
)CMC
occurs
Q
1 =1=
0P1E1Q1 (TR) > 0C1MQ1 (TC)
===CP
11 X
Q
0C
Can TC
also
be
by11MQ
TR
Xfound
Q11 == Profit
0P
ETR
1=
QC111-P1TC
Difference
Economic
E1M
Economic loss: occurs when a firm makes less
than normal profit.
• I.e. price (AR) < AC
Profit isAtEconomic
maximised
where
MR
= P3
3, 3AR
occurs
= (P
Ploss
3 3)
and
Q
3
AtQThis
Q
, AR
<=atAC
CAC
3 (C
–3 =P3=)C3 MC
0P3E3Q3 (TR) < 0C1MQ3 (TC)
TR
===Cbe
PEconomic
33 Xfound
Q33 = 0C
0P
E=TR
3Q
Can TC
also
by33MQ
TC3
Difference
Loss
P333C-3ME
If a firm is making an economic loss,
should they leave the market?
Depends on average revenue (P)
relative to average VARIABLE costs
(shut down rule!).
If P < AVC, best to leave the industry.
To summarise…
Is a firm making an economic profit, normal profit
or economic loss???
STEP 1: Find the point at which profit is maximized
(MR = MC) as this is where all firms will produce.
STEP 2: At the point where MR=MC, what is the
difference between AR & AC?
• AR>AC = economic profit
• AR=AC = normal profit
• AR<AC = economic loss
The rising part of the firm’s MC curve above
minimum of AVC = firm’s supply curve.
Industry in equilibrium in the long run
only if all firms make normal profits only.
• Market forces dictate
• Private firms & gov. have no power
• Market mechanism, (think Adam Smith’s invisible
hand), determines WHAT, HOW and FOR WHOM…
Are perfectly competitive markets fair?
• Must have purchasing power to participate – only
money votes count
• Leads to very uneven distribution of income and
wealth
• Only goods that people ‘vote’ for are produced.