ECO 2023
Chapter 8: Perfect Competition
Market structure
 Describes the important features of a market such as
o Number of suppliers
o The product’s degree of uniformity
o The ease of entry into the market
o The forms of competition among firms
 A firm’s decisions about how much to produce or what
price to charge depend on the structure of the market
 Four market models
o Pure competition
o Pure monopoly
o Monopolistic competition
o Oligopoly
Pure Competition: Characteristics and Occurrence
 A market structure with many fully informed buyers
and sellers of a standardized product and no obstacles
to entry or exit of firms in the long run
o Characteristics
 Many independent buyers and sellers
 Buyers are small relative to the market
 Standardized product – homogeneous
 Price takers – individual firms exert no
significant control over product price.
 Each firm produces such a small fraction
of total output that increasing or
decreasing its output will not influence
total supply or product price
 It takes the market price
 Free entry and exit to the industry
Created by M. Mari
Fall 2007
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ECO 2023
Chapter 8: Perfect Competition
Demand under Pure Competition
 Firm’s demand is perfectly elastic therefore the demand
curve is horizontal. One and only price exists in the
market and it is the equilibrium price
 The firm is therefore a PRICE TAKER
o It does not affect the market price
Price
Price
SUPPLY
$5
$5
D
DEMAND
Quantity
Average Revenue, Total Revenue and Marginal
Revenue
Average revenue
o The firm’s demand schedule is also its average
revenue schedule
o Price per unit to purchaser is also revenue per unit
or average revenue
Total revenue
o PXQ
o Since price is constant, increase in sales of one
unit leads to increase in total revenue = to price.
Created by M. Mari
Fall 2007
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Quantity
ECO 2023
Chapter 8: Perfect Competition
o Each unit sold adds exactly its constant price to
total revenue
Marginal revenue
o Is the change in total revenue that results from
selling 1 more unit of output
o This is the selling price since it is constant
o Therefore: MR = AR = Price
Short run Profit Maximization
 Purely competitive firm is a price taker, it can maximize
its economic profit only by adjusting its output.
 Short run – it has a fixed plant
o Therefore output is changed through changes in
variable inputs.
o It adjusts its variable resources to achieve the
output level that maximizes its profit.
 Two ways to determine level of output at which a
competitive firm will realize maximum profit or
minimum loss
o Compare total revenue to total cost
o Compare marginal revenue to marginal cost
o Both apply to all firms
Created by M. Mari
Fall 2007
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ECO 2023
Chapter 8: Perfect Competition
Bushels
per day
Q
Total
Fixed
Costs
TFC
Total
Variable
costs
TVC
0
1
2
3
4
5
6
7
8
9
10
$100
$100
$100
$100
$100
$100
$100
$100
$100
$100
$100
$0
90
170
240
300
370
450
540
650
780
930
Total
Total
Economic
Cost Revenue profit or
loss
TC
TR = P X
TR-TC
Q where
P =$131
$100
$0
-$100
190
131
-59
270
262
-8
340
393
+$53
400
524
+124
470
655
+185
550
786
+236
640
917
+277
750
1048
+298
880
1179
+299
1030
1310
+280
At a production level of 9 bushels per day leads to
total revenue is $1179 and total cost is $880 earning
the firm a profit of $299.00. The firm has maximized
profit.
Created by M. Mari
Fall 2007
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ECO 2023
Chapter 8: Perfect Competition
Total
Revenue
&
Total
Cost
Total Revenue
Maximum
Economic
Profit
Total Cost
0
Quantity
Demanded
9
Marginal Revenue Equals Marginal Cost
 Marginal revenue
o The change in total revenue from selling an
additional unit
o In perfect competition, marginal revenue is equal
to the market price
o The firm will increase production as long as each
additional units adds more to total revenue than
to cost
 As long as marginal revenue exceeds
marginal cost
Created by M. Mari
Fall 2007
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ECO 2023
Chapter 8: Perfect Competition
Total
Product
Q
0
Average
Fixed Costs
AFC = TFC/Q
$
100.00
Average
Variable
Costs
AVC
Average
Total
Costs
ATC
$ 100.00
Marginal
Costs
MC
Marginal
Revenue
MR = P
Economic
Profit
$ (100.00)
$ 90.00
1
$
100.00
$
90.00
$ 190.00
$ 131.00
$
(59.00)
$ 131.00
$
(8.00)
$ 131.00
$
53.00
$ 131.00
$
124.00
$ 131.00
$
185.00
$ 131.00
$
236.00
$ 131.00
$
277.00
$ 131.00
$
298.00
$ 131.00
$ 131.00
$
299.00
$
280.00
$ 80.00
2
$
50.00
$
85.00
$ 135.00
$ 70.00
3
$
33.33
$
80.00
$ 113.33
$ 60.00
4
$
25.00
$
75.00
$ 100.00
5
$
20.00
$
74.00
$ 94.00
$ 70.00
$ 80.00
6
$
16.67
$
75.00
$ 91.67
$ 90.00
7
$
14.29
$
77.14
$ 91.43
$ 110.00
8
$
12.50
$
81.25
$ 93.75
$ 130.00
9
$
11.11
$
86.67
$ 97.78
$ 150.00
10
$
10.00
$
93.00
$ 103.00
 Golden Rule of Profit Maximization
o To maximize profit or minimize loss; a firm should
produce the quantity at which marginal revenue
equals marginal cost; this rule holds for all market
structures.
Created by M. Mari
Fall 2007
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ECO 2023
Chapter 8: Perfect Competition
Price
MC
ATC
$131
$100
Demand =
Marginal
Revenue =
Price =
Average
Revenue
Profit
12
Quantity
Minimizing Short-Run Losses
 An individual firm in perfect competition has no control
over the market price
 Sometimes, that price may be so low that a firms loses
money no matter how much it produces
o Can either to produce at a loss
o Temporarily shut down
 Short run
o A period too short to allow existing firms to leave
the industry.
 Decision in the short run:
o Continue to produce
 A firm will produce rather than shut down if
total revenue exceeds the VARIABLE COST of
production
o Shut down
 A firm will shut down if total revenue is less
than the VARIABLE COST of production.
 Still incur fixed costs in the short run
Created by M. Mari
Fall 2007
Page 7 of 9
ECO 2023
Chapter 8: Perfect Competition
Price
MC
ATC
$5
$4
Loss
Demand =
Marginal
Revenue =
Price =
Average
Revenue
12
Quantity
The Firm and Industry Short-Run Supply Curves
 If average variable cost exceeds price at all output
rates, the firm will shut down in the short run
 If price exceeds average variable cost, the firm will
produce the quantity at which marginal revenue equals
marginal cost
 Short run supply curve
o A curve that shows the quantity a firm supplies at
each price in the short run; in perfect competition,
that portion of a firm’s marginal cost curve that
intersects and rises above the low point on its
average variable cost curve
Perfect Competition in the Long Run
 If short run has ECONOMIC PROFIT
o It will encourage new firms to enter the market
and may prompt existing firms to get bigger.
o Economic profit will attract resources form the
industries where firms are losing money or
earning only a normal profit
o Increase in supply will drive the price down
Created by M. Mari
Fall 2007
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ECO 2023
Chapter 8: Perfect Competition
o Short run economic profit attracts new entrants in
the long run and may cause existing firms to
expand. Market supply thereby increases, driving
down the market price until economic profit
disappears.
o This long run adjustment continues until the
market supply curve intersects the market
demand curve at a price that corresponds to the
lowest point on each firm’s long run average cost
curve
o Continues until
 Price = MC = ATC
 If short run has ECONOMIC Loss
o It will encourage firms to exit the market or
decrease production
o Decrease in supply will drive the price up
o Economic loss disappears
o This long run adjustment continues until the
market supply curve intersects the market
demand curve at a price that corresponds to the
lowest point on each firm’s long run average cost
curve
o Continues until
 Price = MC = ATC
Perfect Competition and Efficiency
 Productive efficiency
o The condition that exists when market output is
produced using the least cost combination of
inputs
 Minimum average cost in the long run
 Allocative efficiency
o The condition that exists when firms produce the
output most preferred by consumers
 Marginal benefit = marginal cost
Created by M. Mari
Fall 2007
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