PERFECT COMPETITION : PERFECT COMPETITION BY :-
D.N.TIWARI
PGT(ECO)
JNV BAHRAICH UP
In this chapter you will… : dntjnv@yahoo.co.in Learn what characteristics make a market competitive.
Examine how competitive firms decide how much output to produce.
Examine how competitive firms decide when to shut down production temporarily.
Examine how competitive firms decide whether to exit or entry the market.
See how firm behaviour determines a market’s short-run and long-run supply curves. In this chapter you will…
WHAT IS A COMPETITIVE MARKET : dntjnv@yahoo.co.in A perfectly competitive market has the following characteristics:
There are many buyers and sellers in the market.
The goods offered by the various sellers are largely the same.
Firms can freely enter or exit the market. WHAT IS A COMPETITIVE MARKET
WHAT IS A COMPETITIVE MARKET : dntjnv@yahoo.co.in As a result of its characteristics, the perfectly competitive market has the following outcomes:
The actions of any single buyer or seller in the market have a negligible impact on the market price.
Each buyer and seller takes the market price as given. WHAT IS A COMPETITIVE MARKET
WHAT IS A COMPETITIVE MARKET : dntjnv@yahoo.co.in A competitive market has many buyers and sellers trading identical products so that each buyer and seller is a price taker.
Buyers and sellers must accept the price determined by the market. WHAT IS A COMPETITIVE MARKET
The Revenue of a Competitive Firm : dntjnv@yahoo.co.in Total revenue for a firm is the selling price times the quantity sold.
TR = (P Q)
Total revenue is proportional to the amount of output.
Average revenue tells us how much revenue a firm receives for the typical unit sold.
Average revenue is total revenue divided by the quantity sold. The Revenue of a Competitive Firm
The Revenue of a Competitive Firm : dntjnv@yahoo.co.in In perfect competition, average revenue equals the price of the good. The Revenue of a Competitive Firm
The Revenue of a Competitive Firm : dntjnv@yahoo.co.in Marginal revenue is the change in total revenue from an additional unit sold.
For competitive firms, marginal revenue equals the price of the good. The Revenue of a Competitive Firm MR =TR/ Q
Table 14-1: Total, Average, and Marginal Revenue for a Competitive Firm : dntjnv@yahoo.co.in Table 14-1: Total, Average, and Marginal Revenue for a Competitive Firm (MR = ∆TR/∆Q) (AR = TR/ Q) (TR = P x Q) (P) (Q) Marginal Revenue Average Revenue Total Revenue Price Quantity (in litres)
PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVE : dntjnv@yahoo.co.in The goal of a competitive firm is to maximize profit, which equals total revenue minus total cost.
This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost. PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVE
Table 14-2: Profit Maximization: A Numerical Example : dntjnv@yahoo.co.in Table 14-2: Profit Maximization: A Numerical Example (MR - MC) Change in Profit (MC = ∆TC/∆Q) (MR = ∆TR/∆Q) (TR - TC) (TC) (TR) (Q) Marginal Cost Marginal Revenue Profit Total Cost Total Revenue Quantity (in litres)
PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVE : dntjnv@yahoo.co.in Profit maximization occurs at the quantity where marginal revenue equals marginal cost.
When MR > MC increase Q
When MR < MC decrease Q
When MR = MC Profit is maximized. PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVE
Figure 14-1: Profit Maximization for a Competitive Firm : dntjnv@yahoo.co.in Costs and Revenue Quantity 0 Figure 14-1: Profit Maximization for a Competitive Firm
Figure 14-2: Marginal Cost and the Firm’s Supply Curve : dntjnv@yahoo.co.in Price Quantity 0 Figure 14-2: Marginal Cost and the Firm’s Supply Curve
A Firm’s Short-Run Decisions : dntjnv@yahoo.co.in A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions.
Exit refers to a long-run decision to leave the market. A Firm’s Short-Run Decisions
A Firm’s Short-Run Decisions : dntjnv@yahoo.co.in The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.
Sunk costs are costs that have already been committed and cannot be recovered. A Firm’s Short-Run Decisions
A Firm’s Short-Run Decisions : dntjnv@yahoo.co.in The firm shuts down if the revenue it gets from producing is less than the variable cost of production.
Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC A Firm’s Short-Run Decisions
Figure 14-3: The Competitive Firm’s Short-Run Supply Curve : dntjnv@yahoo.co.in Price Quantity 0 Figure 14-3: The Competitive Firm’s Short-Run Supply Curve
A Firm’s Short-Run Decisions : dntjnv@yahoo.co.in The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve. A Firm’s Short-Run Decisions
A Firm’s Long-Run Decision to Enter or Exit : dntjnv@yahoo.co.in In the long run, the firm exits if the revenue it would get from producing is less than its total cost.
Exit if TR < TC
Exit if TR/Q < TC/Q
Exit if P < ATC
A firm will enter the industry if such an action would be profitable.
Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > ATC A Firm’s Long-Run Decision to Enter or Exit
Figure 14-4: The Competitive Firm’s Long-Run Supply Curve : dntjnv@yahoo.co.in Price Quantity 0 Figure 14-4: The Competitive Firm’s Long-Run Supply Curve
THE SUPPLY CURVE IN COMPETITIVE MARKETS : dntjnv@yahoo.co.in Short-Run Supply Curve
The portion of its marginal cost curve that lies above average variable cost.
Long-Run Supply Curve
The marginal cost curve above the minimum point of its average total cost curve. THE SUPPLY CURVE IN COMPETITIVE MARKETS
Figure 14-5: Profit as the Area between Price and Average Total Cost : dntjnv@yahoo.co.in (a) A Firm with Profits (b) A Firm with Losses Price Quantity 0 P ATC Q Quantity 0 Price Figure 14-5: Profit as the Area between Price and Average Total Cost
THE SUPPLY CURVE IN COMPETITIVE MARKETS : dntjnv@yahoo.co.in Market supply equals the sum of the quantities supplied by the individual firms in the market. THE SUPPLY CURVE IN COMPETITIVE MARKETS
The Short Run: Market Supply with a Fixed Number of Firms : dntjnv@yahoo.co.in For any given price, each firm supplies a quantity of output so that its marginal cost equals price.
The market supply curve reflects the individual firms’ marginal cost curves. The Short Run: Market Supply with a Fixed Number of Firms
Figure 14-6: Market Supply with a Fixed Number of Firms : dntjnv@yahoo.co.in (a) Individual Firm Supply (b) Market Supply Price Quantity (firm) 0 Quantity (market) 0 Price Figure 14-6: Market Supply with a Fixed Number of Firms
The Long Run: Market Supply with Entry and Exit : dntjnv@yahoo.co.in Firms will enter or exit the market until profit is driven to zero.
In the long run, price equals the minimum of average total cost.
The long-run market supply curve is horizontal at this price. The Long Run: Market Supply with Entry and Exit
Figure 14-7: Market Supply with Entry and Exit : dntjnv@yahoo.co.in (a) Firm’s Zero-Profit Condition (b) Market Supply Price Quantity (firm) 0 Quantity (market) 0 Price Figure 14-7: Market Supply with Entry and Exit
The Long Run: Market Supply with Entry and Exit : dntjnv@yahoo.co.in At the end of the process of entry and exit, firms that remain must be making zero economic profit.
The process of entry and exit ends only when price and average total cost are driven to equality.
Long-run equilibrium must have firms operating at their efficient scale. The Long Run: Market Supply with Entry and Exit
Why Stay in Business if You Make Zero Profit? : dntjnv@yahoo.co.in Profit equals total revenue minus total cost.
Total cost includes all the opportunity costs of the firm.
In the zero-profit equilibrium, the firm’s revenue compensates the owners for the time and money they expend to keep the business going. Why Stay in Business if You Make Zero Profit?
Why Stay in Business if You Make Zero Profit? : dntjnv@yahoo.co.in An increase in demand raises price and quantity in the short run.
Firms earn profits because price now exceeds average total cost. Why Stay in Business if You Make Zero Profit?
Figure 14-8: An Increase in Demand in the Short Run and the Long Run. : dntjnv@yahoo.co.in (a) Initial Condition Price Quantity (firm) 0 Quantity (market) 0 Price P1 P Firm Market Figure 14-8: An Increase in Demand in the Short Run and the Long Run.
Figure 14-8: An Increase in Demand in the Short Run and the Long Run. : dntjnv@yahoo.co.in (b) Short-Run Response Price Quantity (firm) 0 Quantity (market) 0 Price P1 Firm Market P2 Figure 14-8: An Increase in Demand in the Short Run and the Long Run.
Figure 14-8: An Increase in Demand in the Short Run and the Long Run. : dntjnv@yahoo.co.in (c) Long-Run Response Price Quantity (firm) 0 Quantity (market) 0 Price P1 Market P2 Firm Figure 14-8: An Increase in Demand in the Short Run and the Long Run.
Why the Long Run Supply Curve Might Slope Upward : dntjnv@yahoo.co.in Some resources used in production may be available only in limited quantities.
Firms may have different costs
Marginal Firm
The marginal firm is the firm that would exit the market if the price were any lower. Why the Long Run Supply Curve Might Slope Upward
Summary : dntjnv@yahoo.co.in Summary Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces.
The price of the good equals both the firm’s average revenue and its marginal revenue.
To maximize profit, a firm chooses the quantity of output such that marginal revenue equals marginal cost.
Summary : dntjnv@yahoo.co.in Summary This is also the quantity at which price equals marginal cost.
Therefore, the firm’s marginal cost curve is its supply curve.
In the short run, when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost.
Summary : dntjnv@yahoo.co.in Summary In the long run, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost.
In a market with free entry and exit, profits are driven to zero in the long run and all firms produce at the efficient scale.
Changes in demand have different effects over different time horizons.
Summary : dntjnv@yahoo.co.in Summary In the long run, the number of firms adjusts to drive the market back to the zero-profit equilibrium.
The End : dntjnv@yahoo.co.in The End