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Perfect Competition

Perfect Competition. Chapter 9 ECO 2023 Fall 2007. Market Structure. Describes the important feature of a market such as Number of suppliers Product’s degree of uniformity Ease of entry into the market Forms of competition among firms

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Perfect Competition

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  1. Perfect Competition Chapter 9 ECO 2023 Fall 2007

  2. Market Structure • Describes the important feature of a market such as • Number of suppliers • Product’s degree of uniformity • Ease of entry into the market • 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

  3. Market Models • Pure Competition • Pure Monopoly • Monopolistic Competition • Oligopoly

  4. Perfect Competitive Market • 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

  5. 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. • Free entry and exit into the industry

  6. Perfectly Competitive Market • Demand under Perfect Competition • Firm’s demand is perfectly elastic therefore the demand curve is horizontal • PRICE TAKER • One and only price exists in the market and it is equilibrium price P D Q

  7. Average Revenue • The firm’s demand schedule is also its average revenue schedule • Price per unit to purchaser is also revenue per unit or average revenue

  8. Total Revenue • P X Q • Since price is constant, increase in sales of one unit leads to increase in total revenue = to price. • Each unit sold adds exactly its constant price to total revenue

  9. Marginal Revenue • Is the change in total revenue that results from selling 1 more unit of output • This is the selling price since it is constant • Therefore: MR = AR = Price

  10. Short Run Profit Maximization • Each firms tries to maximize economic profit • Short run – it has a fixed plant • Therefore output is changed through changes in variable inputs. • 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 • Compare total revenue to total cost • Compare marginal revenue to marginal cost • Both apply to all firms • Firms that ignore this strategy do not survive

  11. Example

  12. Graphically Total Revenue Maximum Economic Profit Total Revenue & Total Cost Total Cost Quantity Demanded 9

  13. Marginal Revenue Equals Marginal Cost • Marginal revenue • The change in total revenue from selling an additional unit • In perfect competition, marginal revenue is equal to the market price • 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

  14. Graphically

  15. Golden Rule of Profit Maximization MR = MC

  16. Price MC ATC $5 Demand = Marginal Revenue = Price = Average Revenue Profit $4 12 Quantity Perfectly Competitive Market • Short run economic profit Profit

  17. Perfectly Competitive Market • Minimizing Short-Run Losses • An individual firm in perfect competition has no control over the market price • Price may be so low that a firm loses money no matter how much it produces • Can either produce at a loss • Temporarily shut down • Short run • A period too short to allow existing firms to leave the industry

  18. Perfectly Competitive Market • Decision in the short run • Continue to produce • A firm will produce if • TOTAL REVENUE > VARIABLE COST • Shut down • A firm will shut down • TOTAL REVENUE < VARIABLE COST

  19. Price MC ATC $5 Loss Demand = Marginal Revenue = Price = Average Revenue $4 12 Quantity Perfectly Competitive Market • Short run Losses Loss

  20. Perfectly Competitive Market • Perfect Competition in the Long Run • If short run has ECONOMIC PROFIT • Firms enter the industry • Increase in supply • Price drops • Continues until NO ECONOMIC PROFIT in the long run • Price = Marginal Cost = Average Total Cost

  21. Perfectly Competitive Market • Perfect Competition in the Long Run • If short run has ECONOMIC Loss • Firms leavethe industry • Decrease in supply • Price rises • Continues until NO ECONOMIC PROFIT in the long run • Price = Marginal Cost = Average Total Cost

  22. Perfectly Competitive Market • Productive efficiency • 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 • The condition that exists when firms produce the output most preferred by consumers • Marginal benefits = marginal cost

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