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Chapters 9: Perfect Competition

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Perfect Competition

Assumptions:• Free Entry• All buyers and sellers have perfect information• Many firms producing a homogenous product• Factors of production are perfectly mobile in the long run

Implications:• Firms are “price takers,” that is, they cannot sell anything above the prevailing market price

• The firm’s supply curve will be the portion of their marginal cost curve above their average total cost curve

• In the long run, economic profits are zero

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Perfect Competition: Numeric Example

Quantity

ATC MC ∏(P=22)

∏(P=4)

4 6 10 64 -8

6 8 14 84 -24

8 10 18 96 -48

10 12 22 100 -80

12 14 26 96 -120

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Total Revenue and Total Cost TC

TR

TR TC

Fixed Cost

(-) Fixed Cost

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Perfect Competition: Zero Profit

Demand =Price =Marginal revenue

wheat

Price/Marginal Revenue Marginal cost

Average total cost

Supply curve

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Perfect Competition: Negative Profit (losses)

Demand =Price =Marginal revenue

wheat

Price/Marginal Revenue Marginal cost

Average total cost

losses

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Perfect Competition: Positive Profit

Demand =Price =Marginal revenue

wheat

Price/Marginal Revenue Marginal cost

Average total cost

Profits

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Perfect Competition: Labeling

Curves/Optimums/Profit/Loss

A B C D E

G H I

J K L

M

N O P Q R

S

T

U

V

W

F

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Supply/Shutdown Decision

• Competitive firms will, in the short run, supply products so long as price must equal marginal cost on a rising portion of the MC curve, and it must exceed the minimum value of the AVC curve

MC

AVCSupply

Shut Down

P

Q

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Short-Run Competitive Industry Supply Curve

MC1 MC1 S = MC1 + MC2

10 5 10 4 5 10 204 5

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Elasticity of Supply

• Price elasticity of supply - the percentage change in quantity supplied that occurs in response to a 1 percent change in product price

– Short-run competitive industry supply curve will always be upward sloping because of the law of diminishing marginal returns implying elasticity of supply is always positive

S QS

PP

QdQ

dP

P

Q

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Algebra of Market and IndividualFirm Output

• A market consists of 100 firms. For each firm,

• Total market supply is given by

• If market demand is given by

• Then the profit for each firm is given by

• Profit in the market is equal to

TC Q2 2Q100

ATC Q 2 100 /Q

MC 2Q 2

QiS .5P 1 for P 2

100Qis 100(0.5P 1) QS 50P 100

Qd 2210 5P

TR TC 4220 20(20 2 100 /20) 300

100 i 100300 30,000