ECON107
Principles of
Microeconomics
Week 13
DECEMBER 2013
Chapter-12
1
13w/12/2013
Dr. Mazharul Islam
12
13w/12/2013
PERFECT
COMPETITION
Dr. Mazharul Islam
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Lesson Objectives
 Define
 How
perfect competition
perfect competition arises
 Explain
how a firm makes its output
decision
 Explain
how price and output are
determined in perfect competition
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Dr. Mazharul Islam
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Perfect Competition





Perfect competition is a market in which
Many firms sell identical products to many
buyers (Standardized Product).
There are no restrictions to entry into the
industry (Free Entry and Exit).
Established firms have no advantages
over new ones (Price Takers).
Sellers and buyers are well informed
about prices.
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How Perfect Competition Arises



Perfect competition arises when:
the firm’s minimum efficient scale is small
relative to market demand so there is
room for many firms in the market.
each firm is perceived to produce a good
or service that has no unique
characteristics, so consumers don’t care
which firm’s good they buy.
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Dr. Mazharul Islam
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Perfect Competition
A price taker is a firm that cannot
influence the price of a good or service.
 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.
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Goals of Perfectly Competitive firm
 The
goal of each competitive firm is to
maximize economic profit, which equals
total revenue minus total cost.
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SHORT RUN PROFIT MAXIMIZATION
Two Approaches...
First: Total-Revenue -Total Cost Approach
Second: Marginal-Revenue -Marginal Cost Approach
The Decision Process:
•Should the firm produce (Whether to enter or exit a market)?
•What quantity should be produced?
•What profit or loss will be realized (How to produce at
minimum cost)?
The Decision Rule:
Produce in the short-run if it can realize
1- A profit (or)
2- A loss less than its fixed costs
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DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P) Quantity
Total
Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)
$131
131
131
131
131
131
131
131
131
131
131
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0
1
2
3
4
5
6
7
8
9
10
$
0]
131
]
262 ]
393
]
524 ]
655
]
786
]
917
]
1048]
1179 ]
1310
$131
131
131
131
131
131
131
131
131
131
Dr. Mazharul Islam
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1179
TR
Price and revenue
1048
917
786
655
524
393
262
D = MR
131
0
1
2
3
4
5
6
7
8
9
10
Quantity Demanded (sold)
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Dr. Mazharul Islam
TOTAL REVENUE-TOTAL COST
APPROACH
11
Total Total
Total Fixed Variable Total
Product Cost Cost Cost
0
1
2
3
4
5
6
7
8
9
10
$ 100
100
100
100
100
100
100
100
100
100
100
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$
0
90
170
240
300
370
450
540
650
780
930
$ 100
190
270
340
400
470
550
640
750
880
1030
Price: $131
Total
Revenue Profit
$
0
131
262
393
524
655
786
917
1048
1179
1310
- $100
- 59
-8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 298
+ 299
+ 280
Dr. Mazharul Islam
Total revenue and total cost
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$1,800
1,700
1,600
1,500
1,400
1,300
1,200
1,100
1,000
900
800
700
600
500
400
300
200
100
0
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Break-Even Point
(Normal Profit)
Total
Revenue
Maximum
Economic
Profits
$299
Total
Cost
Break-Even Point
(Normal Profit)
1 2 3 4 5 6 7 8 9 10 11 12 13 14
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Second: Marginal-Revenue -Marginal Cost Approach
Profit is maximized by producing the output at
which marginal revenue (MR), equals marginal
cost (MC).
MR = MC Rule
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Average Average Average
Price = Total
Total Fixed Variable Total Marginal Marginal Economic
Cost
Cost
Product Cost
Cost Revenue Profit/Loss
0
1
2
3
4
5
6
7
8
9
10
$100.00 $90.00 $190.00 90
50.00 85.00 135.00 80
33.33 80.00 113.33 70
25.00 75.00 100.00 60
20.00 74.00
94.00 70
16.67 75.00
91.67 80
14.29 77.14
91.43 90
12.50 81.25
93.75 110
11.11 86.67
97.78 130
10.00 93.00 103.00 150
$ 131
131
131
131
131
131
131
131
131
131
Graphically
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- $100
- 59
-8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 298
+ 299
+ 280
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If MR = MC,
economic profit
decreases if output
changes in either
direction, so
economic profit is
maximized.
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$200
Economic Profit
MC
Cost and Revenue
If MR > MC,
economic profit
increases if
output increases.
If MR < MC,
economic profit
decreases if
output increases.
150
$131.00
MR
ATC
100
$97.78
AVC
50
0
1
2
3
4
5
6
7 8 9 10
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Second: Marginal-Revenue -Marginal Cost Approach
 A firm’s shutdown point is the point at which
it is indifferent between producing and
shutting down.
 This point is where AVC is at its minimum.
 It is also the point at which the MC curve
crosses the AVC curve.
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Dr. Mazharul Islam







Figure shows the shutdown
point.
Minimum AVC is $17 a
sweater.
If the price is $17, the profitmaximizing output is 7
sweaters a day.
The firm incurs a loss equal to
the red rectangle.
If the price of a sweater is
between $17 and $20.14, the
firm produces the quantity at
which marginal cost equals
price.
The firm covers all its
variable cost and at least
part of its fixed cost.
It incurs a loss that is less
than TFC.
17
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Output, Price, and Profit in the Short Run
Market Supply in the Short Run
The short-run market supply curve
shows the quantity supplied by all firms in
the market at each price when each firm’s
plant and the number of firms remain the
same.
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Output, Price, and Profit in the Short Run
Cost and Revenue, (dollars)
Break-even
(Normal Profit)
Point
MC
MR5
P5
ATC
MR4
P4
AVC
MR3
P3
P2
P1
MR2
MR1
Do not
Produce –
Below AVC
Q 2 Q3 Q4
Quantity Supplied
Q5
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Cost and Revenue, (dollars)
Output, Price, and Profit in the Short Run
P5
Yields the
Short-Run
Supply Curve
Supply
MC
MR5
P4
MR4
P3
MR3
P2
P1
MR2
MR1
No
Production
Below AVC
Q2 Q3 Q4
Q5
Dr. Mazharul Islam


At a price equal to
minimum AVC, the
shutdown price, some
firms will produce the
shutdown quantity and
others will produces zero.
The market supply curve is
perfectly elastic.
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Short-Run Equilibrium


Short-run market supply
and market demand
determine the market
price and output.
Figure shows a short-run
equilibrium.
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In part (a) price
equals average
total cost and the
firm makes zero
economic profit
(breaks even).
In part (b), price
exceeds average
total cost and the
firm makes a
positive economic
profit.
In part (c) price is less
than average total
cost and the firm
incurs an economic
loss—economic profit
is negative.
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Now it’s over for today. Do you
have any question?
5w/9/2013
Dr. Mazharul Islam