Bài giảng topic 5 perfect competition

Pure Competition • large number of sellers & buyers • homogenous identical products • low barriers to entry free entry and exit from the industry Perfect Competition • large number of

Perfect Competition

Topic 5

Pure Competition

• large number of sellers & buyers

• homogenous (identical) products

• low barriers to entry (free entry and exit

from the industry)

Perfect Competition

• large number of sellers & buyers

• homogenous (identical) products

• low barriers to entry

• perfect market knowledge

• perfect mobility of FoP’s

Lead to faster adjustment

Price takers & Price makers

Demand curve for a

Price taker

Demand curve for a

Price maker

Demand curve for a Price taker

• The demand curve facing a perfectly competitive firm

is perfectly elastic, meaning that the firm can sell as many units as it wants at the market price, but cannot sell any quantity if it charges more than the market

price.

• The firm has no market power, no pricing power at all

It is just a small player in a large market… It is a price taker.

Demand curve for a Price maker

• Downward sloping.

• It is just matter of how steep the curve is.

• The more market power a firm has, the steeper is the

demand curve.

• The characteristic of a downward sloping demand

curve is that, normally, if a firm raises the price of its product, it needs not lose all its customers, and if it wants to sell more, it has to cut price.

Demand curve for Individual firm

under PC

P = AR = MR

Firm’s D curve Market D curve

Revenue Concepts under PC

• Total revenue (TR): Total number of dollars (or dong)

received by a firm from the sale of a product

• TR = P x Q

• Average revenue (AR): Total revenue per unit of a

product sold

• AR = TR/Q = (P x Q) / Q = P

• Marginal Revenue (MR): Additional revenue received

resulting from the sale of an extra unit of output

• MR = = = P

ΔTR P ΔQ

ΔQ

$ 0131262393524655786917104811791310

131131131131131131131131131

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MarginalRevenue

QuantityDemanded(Sold)

Profit Maximisation in the

Short Run

Two approaches to profit maximisation:

• Total Revenue minus Total Cost Approach

• Marginal Revenue, Marginal Cost Approach

Rules for Profit Maximisation

• Optimum output where: TR – TC = largest

or

• Optimum output where: MR = MC

–or MR closest to MC but MR > MC –MC cuts MR curve from below

Total Revenue – Total Cost

Total

Product

Total Fixed Cost

Total Variable Cost

Total

$ 100

100 100 100 100 100 100 100 100

100

100

$ 0 90 170 240 300 370 450 540 650

780

930

$ 100 190 270 340 400 470 550 640 750

880

1030

$ 0 131 262 393 524 655 786 917 1048

1179

1310

– $100

– 59 – 8 + 53 + 124 + 185 + 236 + 277 + 298

+ 299

+ 280

0

1 2 3 4 5 6 7 8

9

10

100 100 100 100 100 100 100 100 100

100

100

0 90 170 240 300 370 450 540 650

780

930

100 190 270 340 400 470 550 640 750

880

1030

] ] ] ] ] ] ] ] ] ]

Total Cost

Total Product

Total Fixed Cost

Total Variable Cost

Marginal Cost

Total Economic Prof./Loss

Price = Marginal Revenue

Profit Maximisation: MR, MC Approach

90 80 70 60 70 80 90 110

13 0

15 0

$ 131 131 131 131 131 131 131 131

131

131

– $100

– 59 – 8 + 53 + 124 + 185 + 236 + 277 + 298

+ 299

+ 280

Short-run equilibrium of industry and firm

under Perfect Competition

Q (thousands)

Copyright 2001 Pearson Education Australia

Rules for Profit Maximisation

• Optimal output is where MR = MC

 or MR closest to MC but MR > MC

 MC cuts MR curve from below

IMPORTANT ! Rules for Profit maximization

Short Run

P ≥ AVC

• In the short run, fixed costs will be incurred whether or

not the firm produces So this means that total revenue must be at least equal to total variable cost for the firm

to continue producing.

If P < AVC, firm should shut down

IMPORTANT ! Rules for Profit maximization

Long Run

P ≥ ATC

• In the long run, firms have the option of closing down

and going out of business, so total revenue must at least cover total costs ( all costs ).

If P < ATC, firm should shut down

Long run Equilibrium under PC

• Under PC

 P = min ATC = MR = MC

 why?

S1

D

(a) Industry: As firms making

supernormal profits , new firms

will enter the industry S curve

shifts to right Price falls.

S1

D

(a) Industry: As firms making

losses , some firms will leave

the industry S curve shifts to

left Price rises.

Long run Equilibrium

• .

Long run Equilibrium

• Key characteristics of PC:

– identical products

– freedom of entry & exit

• Implication (or conclusion)

profits in the long run

Allocative efficiency:

• Resources are allocated among firms and

industries to obtain a mix of products most desired

by society (consumers)

Productive efficiency:

• The least costly methods of production are used

(ie goods are produced at the lowest possible

costs)

Efficiency and Perfect

Competition

• Price of product X = the relative worth of product X to the society (or the marginal benefit/satisfaction the

society gets from an additional unit of X)

• Marginal Cost of product X is the cost of producing an additional unit of X

(MC measures the sacrifice of other goods in using

resources to produce more of X)

Efficiency and Perfect

Competition

• Allocative efficiency:

 P > MC : resources are under allocated

 P < MC : resources are over allocated

 P = MC : resources are best

Assessment of Perfect Competition

Pros

• Productive efficiency: min AC (ie firms

produce at the least-cost output)

• Allocative efficiency: P = MC

• Consumer gains from low prices (ie

maximum consumer surplus)

• Speed of resource reallocation

• No power groups

Cons

• Less scope for R&D

• Almost no product variety

Short-Run Supply Curve

• For the individual firm: the SR supply curve is the

MC curve above the AVC curve

• For the entire industry: horizontal sum of firms’ MC

curves above AVC

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

Q3

P3

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

Q2

P2

P3

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

Q4

Break-even (normal profit)

point

P4

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

supply curve

P = MC: Short-Run Supply Curve

P

Q

MC

AVC ATC

(red)

P = MC: Short-Run Supply Curve

P = MC: Short-Run Supply Curve