Perfect Competition

Perfect Competition
The concept of competition is used in
two ways in economics.
Competition as a process is a rivalry among
firms. (competitive behaviour)
Competition as the perfectly competitive
market structure.
Competition as a Market
Structure
It is possible to imagine something that
does not exist a perfectly competitive
market in which the invisible hand works
unimpeded.
A Perfectly Competitive
Market
A perfectly competitive market is
onewhere there are large number of
buyers and sellers , the firms produce
homogenous products and price remain
uniform .
This is so because , the individual firms
has less power to influence the market in
which it sells , so more competitive the
market is
Competitive Behaviour

This refers to the degree to which
individual firms actively compete with
each other , tries to take away each
others market share .
Example .
Shell and Bp engage in competitive
behaviour .
Each could raise the prices of petrol , and
still attract customers , it has a little
power to influence . Whithin the limits of
buyers .
Features of perfect
competition

Both buyers and sellers are price takers.
The number of firms is large.
Very large no of buyers and sellers
There are no barriers to entry and exit of
firms
The firms' products are identical.
There is complete information.
Firms are profit maximizers.
AR remains the same , AR=MR
Demand Curves for the Firm
and the Industry
The demand curves facing the firm is
different from the industry demand
curve.
A perfectly competitive firms demand
schedule is perfectly elastic even though
the demand curve for the market is
downward sloping.
Demand Curves for the Firm
and the Industry
This means that firms will increase their
output in response to an increase in
demand even though that will cause the
price to fall thus making all firms
collectively worse off.
Market supply
Market
demand
1,000 3,000
Price
$10
8
6
4
2
0
Quantity
Market Firm
Individual firm
demand
Market Demand Versus Individual
Firm Demand Curve
10 20 30
Price
$10
8
6
4
2
0
Quantity
Profit-Maximizing Level of
Output
The goal of the firm is to maximize
profits.
When it decides what quantity to
produce it continually asks how changes
in quantity affect profit.
Profit-Maximizing Level of
Output
Since profit is the difference between
total revenue and total cost, what
happens to profit in response to a change
in output is determined by marginal
revenue (MR) and marginal cost (MC).
A firm maximizes profit when MC = MR ,
MC is greater than MR after they are
equal level of output
Profit-Maximizing Level of
Output
Marginal revenue (MR) the change in
total revenue associated with a change in
quantity.
Marginal cost (MC) -- the change in
total cost associated with a change in
quantity.
Marginal Revenue and Marginal
Cost
Since a perfect competitor accepts the
market price as given, for a competitive
firm, marginal revenue is price (MR = P).

Initially, marginal cost falls and then
begins to rise



How to Maximize Profit
If marginal revenue does not equal
marginal cost, a firm can increase profit
by changing output.
The supplier will continue to produce as
long as marginal cost is less than
marginal revenue.
The supplier will cut back on production
if marginal cost is greater than marginal
revenue.
Thus profit will maximise at MC=MR=p

The Marginal Cost Curve Is the
Supply Curve
The marginal cost
curve is the firm's
supply curve above
the point where
price exceeds
average variable
cost.
This is because
equilibirium is
where MC=MR, but
MC=P

Profit Maximization Using
Total Revenue and Total Cost
Profit is maximized where the vertical
distance between total revenue and total
cost is greatest.
At that output, MR (the slope of the
total revenue curve) and MC (the slope
of the total cost curve) are equal.
PROFIT equals to TR-TC
TC TR
0
T
o
t
a
l

c
o
s
t
,

r
e
v
e
n
u
e

$385
350
315
280
245
210
175
140
105
70
35
Quantity 1 2 3 4 5 6 7 8 9
Profit Determination Using
Total Cost and Revenue Curves
Maximum profit =$81
$130
Loss
Loss
Profit
The Shutdown Point
The firm will shut down if it cannot cover
average variable costs.
A firm should continue to produce as long as
price is greater than average variable cost.
Once price falls below that point it makes
sense to shut down temporarily and save the
variable costs.
The shutdown point is the point at which the
firm will gain more by shutting down than it
will by staying in business.

Short Run Equilibrium price
In short time period , the producer must
be able to cover his variable cost . So
the firm tries to cover at least variable
cost of this period , as the fixed costs
have to be beared by the company .
In short time period , frim can earn
profit if the p is above than atc.
Long run equilibrium price
In The long period , the firm atleast must
be able to cover the ATCs or else it will
go to losses .
So the price set should be more than ATC
or equal to ATC .
It can be equal because , in economics we
inckude normakl profits in total revenue .
Long Run

Firms enter if economic profits > 0
market supply increases
price declines
profit declines until economic profit equals zero
(and entry stops)
Firms exit if economic losses occur
market supply decreases
price rises
losses decline until economic profit equals zero
Consumer Surplus
Consumer surplus is the difference
between total value that consumers place
on all the units consumed by product and
the payment that they actually make for
purchase of product

PRODUCERS SURPLUS
Producers surplus is defined as the
amount that producers are paid for a
product less the total cost of production


Allocative Efficiency
Allocative efficiency occurs where the
sum of consumer surplus and producer
surplus gets maximised .
Allocatively efficient output in perfect
competiton occurs when the demand
curve intersects the supply curve