Introduction to Microeconomics
Perfect Competition
Quoc Thai Le*
April 27, 2025
* EFA, International University, VNU-HCM
Materials/Readings
▶ Mankiw, N. G. (2024). Principles of Economics, 10th Edition.
Chapter 15. Boston, MA: Cengage.
▶ https://blackboard.hcmiu.edu.vn/
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Market structure
Market structure: the organization of a market
▶ Market power: the ability (of buyers/sellers) to influence the
market price of a good/service
▶ The level/degree of competition in a market is reflected via
market power
=⇒ What can reflect a firm’s market power?
=⇒ How to quantitatively measure a firm’s market power?
=⇒ What can theoretically/empirically reflect the level of
competition in a market?
Notes: Jan De Loecker
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Market structure: the ideal perfect competition
▶ A market is competitive if each buyer/seller is relatively small
as compared with the size of the market and, therefore, has
little ability to influence the market price.
=⇒ Can an infinite number of firms imply that a market is
competitive?
▶ Perfect competition:
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Market structure: a classification
No. of sellers
1
No. of buyers
n
1
bargaining
monopsony
n
monopoly
perfect competition
Notes: The Table shows a classification of market structures given good/service homogeneity.
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Market structure: a classification
No. of buyers: n
No. of sellers:
Good/Service:
homogeneity
unique
heterogeneity
1
a few
several
n
cartel/oligopoly
perfect competition
oligopoly
monopolistic competition
monopoly
Notes: The Table shows a classification of market structures, taking into account
good/service homogeneity/heterogeneity ⇐= How to determine good/service
homogeneity?
=⇒ How differently do firms behave in each market structure?
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From market to industry
▶ Industry: a group of firms that supply
identical/similar/competing goods/services
=⇒ the (primary) good/service that is offered ←− economic
activities
=⇒ the supply side of the market
=⇒ Example?
=⇒ How are industries coherently/consistently
categorized/classified?
▶ Industry inter-relation
horizontal
vertical
Notes: the International Standard Industrial Classification of All
Economic Activities (ISIC) versus the Harmonized System (HS)
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Industry horizontalization
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Industry verticalization: global value chain
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Revenues
Revenues: the rewards of doing business
▶ TR = P × Q
=⇒ What determines prices in perfect competition?
=⇒ How can a firm in a perfectly competitive market
increase their total revenues?
TR
▶ AR =
= P =⇒ What does it reflect?
Q
▶ MR =
∆T R
dT R
=
= P =⇒ What does it reflect?
∆Q
dQ
M R = P is only true for firms in perfect competition (a
horizontal curve) ⇐= Why?
since M R = P > 0, T R is . . . . . . . . . . . . . . . . . . in Q
=⇒ AR = M R = P in perfect competition ⇐= the perfectly
competitive firm’s demand curve
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Revenues: the rewards of doing business
Quantity
(Q)
Price
(P )
0
10
1
10
2
10
3
10
4
10
5
10
6
10
7
10
8
10
Total revenues
(T R)
Average revenues
(AR)
Marginal revenues
(M R)
Notes: The Table illustrates various measures of a perfectly competitive firm’s
revenues
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Firm’s/Market’s demand curves in perfect competition
▶ Perfectly competitive firms are a price-taker
▶ While the market demand curve slopes downwards, the demand
curve for an individual firm is horizontal at the market price P
=⇒ While a perfectly competitive firm i can increase/decrease qi ,
P remains unchanged; thus M Ri = M R = P for perfectly
competitive firms
=⇒ The M R curve (a horizontal curve) is equivalent to the
demand curve facing perfectly competitive firms (a perfectly
elastic demand curve)
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Firm’s/Market’s demand curves in perfect competition
Price $3.5
Demand
Supply
Price $3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
MC
1.5
P = MR
1.0
1.0
0.5
0.5
5
10
The market
15
20
25
Quantity (in millions)
D = MR
500
1,000
1,500
2,000
2,500
Quantity
The perfectly competitive firm
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Exercises: revenues
When a perfectly competitive firm increases the quantity it
produces and then sells by 10 percent, its marginal revenues
. . .(1). . . and its total revenues rise by . . .(2). . .
A. falls; less than 10 percent
B. falls; exactly 10 percent
C. falls; more than 10 percent
D. stays the same; less than 10 percent
E. stays the same; exactly 10 percent
F. stays the same; more than 10 percent
G. rises; less than 10 percent
H. rises; exactly 10 percent
I. rises; more than 10 percent
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Profit maximization
Profit maximization
▶ Profits = T R − T C = P × Q − T C
▶ A profit-maximizing firm picks the (optimal) quantity Q that
maximizes its profits
▶ Qoptimal = argmax (T R − T C) = argmax (P × Q − T C)
Q
Qoptimal = M R ∩ M C =
Q
(
perfect competition
P ∩ MC
perfect competition: Qoptimal ⇐⇒ P = M R = M C
▶ If Q increases by one unit, then
both revenues rises by M R and costs rises by M C
if M R > M C then profits rise
if M R < M C then profits fall
▶ At any Q with M R > M C, increasing Q raises profits.
▶ At any Q with M R < M C, decreasing Q raises profits.
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Profit maximization
Quantity
(Q)
Total revenues
(T R)
(P = 6)
Total costs
(T C)
0
3
1
5
2
8
3
12
4
17
5
23
6
30
7
38
8
47
Profits
(T R − T C)
Marginal revenues
(M R)
Marginal costs
(M C)
∆profits
(M R − M C)
Notes: The Table illustrates a firm’s profit maximization.
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Profit maximization
Price $3.5
he blue
Cheeseoint B,
profits,
MC
3.0
2.5
2.0
B
1.5
MR = Price
1.0
A
0.5
Qoptimal
500
1,000
1,500
2,000
2,500
Quantity
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Supply decision/curve
A firm’s supply decision in perfect competition
▶ If M R > M C, the firm should increase Q
▶ If M R < M C, the firm should decrease Q
▶ At Qoptimal , M R = M C −→ any change in Q would reduce
profits
▶ Qoptimal = M R ∩ M C = P ∩ M C
▶ If P rises/falls (due to a certain shock), Qoptimal rises/falls
accordingly
▶ A firm’s M C determines Q that the firm is willing to supply at
any price =⇒ M C is the perfectly competitive firm’s supply
curve
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2
2
2
reducing production increases profit. The profit-maximizing quantity, QMAX, is found where
the horizontal line representing the price intersects the marginal-cost curve.
A firm’s supply curve in perfect competition
Costs
and
Revenue
The firm maximizes profit
by producing the quantity
at which marginal cost
equals marginal revenue.
MC
MC2
ATC
P = MR1 = MR2
AVC
P = AR = MR
MC1
0
Q1
Q optimal
Q2
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Quantity
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A firm’s supply curve in perfect competition
Price
MC
P2
ATC
P1
0
AVC
Q1
Q2
Quantity
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Shutdown/Suspension versus exit
▶ shutdown: a short-run decision to not produce anything at all
during a specific period of time (due to current market
conditions)
=⇒ F C still need to be paid
▶ exit: a long-run decision to leave the market.
=⇒ no costs (either F C or V C) need to be paid at all
=⇒ the ability to avoid F C differs in the short versus long runs!
=⇒ Examples?
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Supply decision/curve
Short-run supply decision/curve
Shutdown/Suspension: a firm’s short-run decision
▶ A firm’s short-run decision: shutdown/suspension versus
production
▶ What do firms need to compare when making a shutdown
decision?
the costs of shutdown: a loss of T R
the benefits of shutdown: a saving of V C
shutdown ⇐⇒ T R < V C ⇐⇒
TR
VC
<
⇐⇒ P < AV C
Q
Q
▶ If the costs of shutdown are less than the benefits, the firm
should shut down
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A firm’s short-run supply curve in perfect competition
▶ A firm’s short-run profit-maximizing strategy in perfect
competition:
If P > AV C it produces Q at which P = M C
If P < AV C it shuts down temporarily (Q = 0)
=⇒ A firm’s short-run supply curve in perfect competition is the
portion of its M C curve that lies above the AV C curve.
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A firm’s short-run supply curve in perfect competition
Costs
1. In the short run, the firm
produces on the MC curve if
P . AVC,...
MC
ATC
AVC
2. ...but shuts
down if
P , AVC.
0
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Quantity
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Sunk costs
▶ sunk costs: a special type of costs that can, once have already
been committed, never be recovered =⇒ Examples?
▶ Sunk costs should be irrelevant to decision-making about
various aspects of life, including business strategies −→ they
shall be ignored in any decision-making process
▶ Sunk costs still must be paid regardless of your choice
=⇒ F C are a sunk cost in the short run: the firm must pay its
fixed costs regardless of the quantity of output supplied −→
F C shall not matter in the decision to shut down as well as
the decision on how much to supply.
=⇒ The size of F C shall not matter the a firm’s short-run supply
curve
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Supply decision/curve
Long-run supply decision/curve
Entry/Exit: a firm’s long-run decision
▶ A firm’s long-run decision: exit versus entry
▶ What do firms need to compare when making an exit
decision?
the costs of exit: a loss of T R
the benefits of exit: a saving of T C
exit ⇐⇒ T R < T C ⇐⇒
TR
TC
<
⇐⇒ P < AT C = AV C
Q
Q
▶ If the costs of exit are less than the benefits, the firm should
exit
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Entry/Exit: a firm’s long-run decision
▶ A firm’s long-run decision: exit versus entry
▶ What does an entrepreneur need to compare when
making an entry decision?
the costs of entry: a loss of T C
the benefits of entry: a gain of T R
entry ⇐⇒ T R > T C ⇐⇒
TR
TC
>
⇐⇒ P > AT C = AV C
Q
Q
▶ If the costs of entry are less than the benefits, the firm should
enter the market
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A firm’s long-run supply curve in perfect competition
▶ A firm’s long-run profit-maximizing strategy in perfect
competition:
If P > LAT C it produces Q at which P = M C
If P < LAT C it either exits or not enter the market (Q = 0)
=⇒ A firm’s long-run supply curve in perfect competition is the
portion of its M C curve that lies above the LAT C curve.
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A firm’s long-run supply curve in perfect competition
Costs
1. In the long run, the firm
produces on the MC curve if
P . ATC,...
MC
ATC
2. ...but
exits if
P , ATC.
0
Quantity
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Profits
A perfectly competitive firm’s profits
▶ Profits = T R − T C =
TR TC
−
Q
Q
× Q = (P − AT C) × Q
Qoptimal = argmax (T R − T C) = M R ∩ M C = P
| ∩{zM C}
Q
perfect competition
per-unit profits = P − AT C
=⇒ How to graphically determine a firm’s total profits?
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The height of this box is price minus averag
Profit as the Area between
the quantity of output (Q). In panel (a), pric
A perfectly
firm’s positive
profitsprofit. In panel (b), price is less tha
Price andcompetitive
Average Total Cost
A Firm with Profits
Price
Price
Profit
MC
ATC
P
ATC
P = AR = MR
ATC
P
Lo
0
Q
(profit-maximizing quantity)
Quantity
Market structure Revenues Profit maximization Supply decision/curve Profits Market supply Discussions
0
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box is price minus average total cost (P 2 ATC), and the width of the box is
put (Q). In panel (a), price is greater than average total cost, so the firm has
A perfectly competitive firm’s profits
panel (b), price is less than average total cost, so the firm incurs a loss.
A Firm with Losses
Price
ATC
MC
R = MR
ATC
ATC
P
P = AR = MR
Loss
Quantity
0
Q
(loss-minimizing quantity)
Quantity
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Rules for profit maximization in perfect competition
▶ Perfect competition: Qoptimal = M R ∩ M C = P ∩ M C
▶ If P < AV C then shut down immediately, exit the market and
stay out of business
▶ If AV C < P < AT C then operate in the short run but exit in
the long run
▶ If AT C < P then enter the market immediately, remain in
business and enjoy the profits
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Market supply
Assumptions
▶ Homogeneity: firms are identical in terms of costs
▶ Each firm’s costs do not change as other firms enter/exit the
market
▶ The number of firms (n) in the market is
fixed in the short run (due to fixed costs)
variable in the long run (due to free entry/exit) ⇐= What
does it imply?
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Short-run market supply
▶ In the short run, n is fixed
▶ As long as P ≥ AV C, each firm i supplies a quantity of
output qioptimal at which P = M Ri = M Ci . Each firm’s
marginal cost curve (that lies at/above the AV C curve) is its
supply curve (si ≡ M Ci : M Ci ≥ AV Ci )
▶ At each P , the quantity of output supplied to the market
equals the sum of the quantities supplied by each firm
(QS =
n
X
optimal
qi
= n × q)
i=1
=⇒ The market supply curve is derived from (horizontally)
aggregating the quantity supplied by each firm in the market
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Short-run market supply (n = 1000)
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Long-run market supply
▶ In the long run, n is variable due to free entry/exit
▶ If existing firms in the market earn positive economic profits,
new firms enter the market
short-run market supply shifts rightwards
P falls
profits reduce
entry is slowed down gradually and eventually halts
▶ If existing firms in the market incur losses
some firms exit the market
short-run market supply shifts leftwards
P rises
remaining firms’ losses reduce
exit is slowed down gradually and eventually halts
=⇒ What is eventually the equilibrium of the entry/exit
process?
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Long-run market supply
Price $2.0
D
S1
S2
1.5
Price $2.0
MC
LATC
1.5
A
MR1
1.0
P 5 ATCmin
1.0
B
MR2
E
0.5
0.5
500
Price $2.0
1,000
1,500
2,000
2,500
Quantity (market)
S2
D
S1
5
10
15
Price $2.0
20
25
Quantity (firm)
MC
LATC
1.5
1.5
1.0
E
1.0
P 5 ATCmin
B
MR2
MR1
A
0.5
0.5
500
1,000
1,500
2,000
2,500
Quantity (market)
5
10
15
20
25
Quantity (firm)
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Long-run market supply: the zero-profit condition
▶ Long-run equilibrium: at the end of the entry/exit process,
firms that remain in the market must be earning zero economic
profits
▶ Profits = (P − AT C) × Q = 0 ⇐⇒

Q = Q
optimal > 0
P = AT C
▶ Consequently P = M R = M C = AT C =⇒ firms are only
covering their costs of operations (both fixed and variable)
▶ In addition M C ∩ AT C = min AT C
Q
▶ Therefore
in the long run

P = M R = M C = min AT C
optimal = argmin AT C −→ the firm’s efficient scale
Q = Q
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Long-run market supply
▶ If P =
̸ min AT C −→ profits/losses −→ the entry/exit process
−→ equilibrium at P = min AT C −→ profits/losses = 0
▶ The number of firms in the market (n) adjusts so that
P = min AT C
▶ In the long run, a typical firm earns zero (economic) profits
▶ New firms have no incentive to enter the market while existing
firms have no incentive to exit the market
▶ There are enough firms to satisfy all the demand at
P = min AT C
=⇒ The long-run market supply curve is horizontal at
P = min AT C
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Long-run market supply
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Discussions
Discussions
Why do firms remain in business given that
profits = 0?
Why do firms remain in business given that profits = 0?
▶ Economic profits = T R − T C = 0
▶ Equivalently T R = T C = Explicit costs + Implicit costs
▶ At the zero-profit equilibrium
firms earn enough revenues to cover both explicit and implicit
costs
accounting profits are positive
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Discussions
Effects of a demand shift in both the short and
long runs
Effects of a demand shift in both the short and long runs
▶ How does the market respond to changes in demand?
−→ Due to free entry/exit in the long run but not in the short run,
the market’s response to a change in demand depends on the
time horizon
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Effects of a demand shift in both the short and long runs
▶ A typical firm begins with a long-run equilibrium: it is earning
zero (economic) profits since P = min AT C
▶ Then the demand curve shifts rightwards/leftwards (due to a
certain reason), leading P to increase/decrease
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Figure 8
Panel (a) shows a market in a long-run equilibrium at point A. In this equilibrium, each firm mak
zero profit, and the price equals the minimum average total cost. Panel (b) shows what happens
the short run when demand rises from D1 to D2. The equilibrium goes from point A to point B, pr
rises from P1 to P2, and the quantity sold in the market rises from Q1 to Q2. Because price now
exceeds average total cost, each firm now makes a profit, which, over time, encourages new firms
to enter the market. Panel (c) shows how this entry shifts the short-run supply curve to the right
from S1 to S2. In the new long-run equilibrium, point C, price has returned to P1, but the quantity
sold has increased to Q3. Profits are again zero, and price is back to the minimum of average tota
cost, but the market has more firms to satisfy the greater demand.
Effects of a demand shift in both the short and long runs
An Increase in Demand in the
Short Run and Long Run
Initial Condition
Market
Price
Firm
Price
1. A market begins in
long-run equilibrium…
MC
Short-run supply, S1
P1
A
2. …with the firm
earning zero profit.
Long-run
supply
P1
Quantity (market)
0
ATC
Demand, D1
0
Q1
Quantity (firm)
Short-Run Response
Market
Price
Firm
Price
3. But then an increase
4. …leading to
in demand raises the
short-run profits.
price…
S1
MC
ATC
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Supply decision/curve Profits Market supply Discussions
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Effects of a demand shift in both the short and long runs
▶ The firm responds to a higher/lower P by
increasing/decreasing its output quantity (q), and accordingly
the market reaches a new short-run equilibrium
▶ At the new short-run equilibrium: P ̸= AT C thus the firm is
making short-run profits/losses
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long-run equilibrium…
earning zero profit.
MC
ATC
Short-runshift
supply, S in both the short and long
Effects of a demand
runs
1
P1
A
Long-run
supply
P1
Quantity (market)
0
Demand, D1
0
Q1
Quantity (firm)
Short-Run Response
Market
Price
P2
P1
B
S1
Firm
3. But then an increase
in demand raises the
price…
Price
4. …leading to
short-run profits.
MC
ATC
P2
A
Long-run
supply
P1
Quantity (market)
0
D2
D1
0
Q1
Q2
Quantity (firm)
Long-Run Response
Market
Firm
Price
Price
5. When profits induce entry,
6. …restoring longsupply increases and the
run equilibrium.
S1 price falls,…
MC
ATC
Market structure Revenues Profit
maximization
Supply
decision/curve
Profits
Market supply Discussions
B
S
2
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Effects of a demand shift in both the short and long runs
▶ The profits/losses induce new/existing firms to enter/exit the
market, thus the number of firms in the market rises/falls, and
consequently the short-run supply curve shifts
rightwards/leftwards, causing P to fall down/rise up
▶ P is as a result driven back to min AT C, thus profits = 0, and
the entry/exit process stops.
▶ Eventually, the market reaches a new long-run equilibrium, at
which P = min AT C (the market price remains the same)
while Q has risen/fallen
▶ At the new long-run equilibrium: q = argmin AT C (the firm’s
efficient scale remains the same) while Q = n × q has
risen/fallen as n increases/decreases
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S1
in demand raises the
price…
short-run profits.
ATC
Effects
of a demand shift in both the
short andMC long
runs
P
P
B
2
P1
2
A
Long-run
supply
P1
Quantity (market)
0
D2
D1
0
Q1
Q2
Quantity (firm)
Long-Run Response
Market
Price
P2
P1
B
Firm
5. When profits induce entry,
supply increases and the
S1 price falls,…
S2
C
A
Price
6. …restoring longrun equilibrium.
MC
Long-run
supply
P1
Quantity (market)
0
ATC
D2
D1
0
Q1
Q2
Q3
Quantity (firm)
h15_ptg01.indd 304
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Discussions
Why might the long-run market supply curve
slope upwards?
Potential of an upward-sloping long-run market supply curve
▶ The long-run market supply curve is horizontal if and only if
both homogeneity (all firms are identical in terms of costs)
and costs do not change as other firms enter/exit the market
▶ If either assumption is not true, then long-run market supply
curve slopes upwards despite free entry/exit
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When homogeneity fails to hold true
▶ Heterogeneity: costs do vary across firms ⇐= Why?
▶ At any P , firms with lower/higher costs are more likely to
enter/exit than firms with higher/lower costs
▶ To increase/decrease market supply in response to a shift in
demand, P must rise/fall to make entry/exit worthwhile for
higher-cost firms
▶ Hence the long-run market supply curve slopes upwards despite
free entry/exit
▶ At any P in the long run
the marginal firm has
lower-costs firms have
(
P = min AT C
profits = 0
(
P > min AT C
profits > 0
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When homogeneity fails to hold true
Short-run
Long-run
Homogeneity: all firms are identical in terms of costs
− Positive economic profits are possible − All firms earn zero economic profits
− Upward-sloping market supply curve
− Horizontal market supply curve
Heterogeneity: costs do vary across firms
− Positive economic profits are possible − All firms except the marginal firm earn positive economic profits
− Upward-sloping market supply curve
− Upward-sloping market supply curve
Notes: The Table illustrates various outcomes in perfect competition.
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When costs vary with the entry/exit of other firms
▶ Resources used in the production of a certain good/service may
be limited
▶ Entry/Exit increases/decreases demand for inputs, causing
input prices to rise/fall, and eventually driving all firms’ costs
up/down
▶ To increase/decrease market supply in response to a shift in
demand, P must rise/fall in accordant with the rise/fall in
firms’ costs
▶ Hence the long-run market supply curve slopes upwards despite
free entry/exit
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Potential of an upward-sloping long-run market supply curve
▶ A higher/lower price may be necessary to induce a
larger/smaller quantity supplied
▶ The long-run market supply curve is upward-sloping instead of
horizontal
▶ With
 an upward-sloping long-run market supply curve,

P > min AT C






profits > 0




 P = min AT C



profits = 0
for lower-cost firms
for the marginal firm
=⇒ Since entry/exit is more easily in the long run than in the short
run, the long-run market supply curve is typically more elastic
than the short-run market supply curve.
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Discussions
Market efficiency
Efficiency of a perfectly competitive market
▶

profit maximization: M R = M C
perfect competition: P = M R
=⇒ At the equilibrium: P = M R = M C
▶ While P is the value to buyers of consuming a marginal unit,
M C is the cost to sellers of supplying a marginal unit.
=⇒ The perfectly competitive equilibrium is efficient =⇒
Total/Social surplus is maximized
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