The perfectly competitive markets

The Demand Curve Faced by the Firmowing to its smallness relative to the market, the firm can actually sell as much output as it wants without influencing the price.. elastic demand curv

The Perfectly Competitive

Market

Economics 11

UPLB

Market Economy

exchange goods or services

helps answer the basic economic questions of what, how much and for whom to produce

different commodities

to various units with the help of a pricing

mechanism

The Market System

coffee, clothes and many others

of these commodities like steel, minerals and labor

 the number of sellers or buyers

 demand for the commodity

 control in the market

Two General Types of Markets

features]

 Monopoly – one firm

 Oligopoly – two or more, but few firms

 Monopolistic competition – many firms selling

differentiated products

5 Features of Perfectly Competitive Market

market

The Demand Curve Faced by the Firm

owing to its smallness relative to the market, the firm can actually sell as much output as it wants without influencing the price

elastic demand curve

 the equilibrium price is still determined in the

market by the forces of demand and supply

P

Q d

Revenues of the Firm

 Total revenue (TR) is the firm's gross income from the sale of its product

TR=P.Q

 Marginal revenue (MR) is the additional revenue earned from

each additional unit of output sold

MR=∆TR/∆Q

 Average revenue (AR) is total revenue divided by output.

AR=TR/Q

Equilibrium price is determined

Equilibrium price is determined

FIGURE 6.1 The market and firm demand curves for a perfectly competitive good

In the left panel of this diagram, we find a downward sloping market demand curve for the good Its intersection with the market supply curve determines the equilibrium price

(P*) that will prevail in the market Since a perfectly competitive firm can sell all that it wants at P*, the firm’s demand curve is the horizontal line shown at the right panel of this

diagram.

P

Q 0

Output Price Total Revenue Marginal Revenue Total Cost Marginal Cost Profit

Deriving profits from the TR and TC curves

 Top panel

TC curve For these levels of output, the firm’s profits are positive

that the firm’s profits at these levels of output are zero since TR=TC

below the TC curve, which implies that the profits are negative.

Bottom Panel -

the slope of the TC curve (TC) are equal Hence, Q* is the firm’s

profit-maximizing level of output.

Total Revenue TR = 0P*AQ*, Total Cost TC = 0CBQ*,

Profit π= CP*AB

Profit maximization for a perfectly

competitive firm

 The firm maximizes its profit at the intersection of the MR and

MC curves (point A) This means that the firm’s

profit-maximizing level of output is equal to Q*.

 How large is the firm’s profit?

 The firm’s total revenue is equal to the product of the price (line segment 0P*) and its output (line segment 0Q*) This suggests that its total

revenue is equal to the area 0P*AQ*

 On the other hand, the firm’s total cost is equal to the product of its

average cost at Q* (line segment 0C) and its output (line segment 0Q*) This means that total cost is equal to the area 0CBQ*

 Since profit is equal to TR less TC, it is therefore equal to the difference between areas 0P*AQ* and 0CBQ* In other words, the firm’s profit is equal to CP*AB

The effects of a fall in the output price

 Since profit maximization requires the equality between MR and MC, the fall in the price leads

to a fall in the firm’s output from Q1 to Q2

 Profit also decreases

Break even point

 When price falls down to P3 , price equals the

lowest point of the firm’s average cost curve.

 This means that the firm’s total cost and total revenue are equal

 Thus, the firm’s profit at P3 is equal to zero We refer to this as the break-even point.

PRICE falls below AC at P4

If price falls below AC at P4 The firm incurs a loss but must continue to produce to minimize losses.

A

B C

D E

Loss Minimization at a price between the minimum

AC and AVC curves

minimum points of the AC and AVC curves, MR =

MC at point A, and the best output level is equal to

Q 4

produce If the firm decides to stop production, it will still continue to pay for its fixed costs ECBD

from closing down are larger than its losses from continued production.

P5

Q5* 0

loss

P5= MR5= AR5

At P5 = min AVC, the loss is equal to the Total Fixed Cost (TFC), which is the also the loss if the firm did not produce Therefore the firm should shut down.

Firm’s Supply Curve:

Portion of MC curve above the AVC curve

Long Run Equilibrium

is such that it is profitable for firms to operate.

 Positive profits will attract new firms into the

industry

 Supply curve will shift to the right

 Price will decline until profit is driven down to zero

Long Run Equilibrium

D-S conditions) is such that it not profitable for firms to operate.

 Negative profits will make some firms leave the

industry

 Supply curve will shift to the left

 Price will increase until profit is no longer negative

At Po, firms are reaping profits New

firms are attracted as long as profits

are positive Supply curve shifts to

the right, so price falls.

Q1

SAC1

Q 0

Constant cost industry

 Suppose that the industry’s initial long-run equilibrium corresponds to price and output levels P0 and Q0,

 We have a constant cost industry if the shift in the

supply curve leads to a long-run equilibrium wherein the market price goes back to P0

D0 D1P

Q Quantity

SAC1

Q 0

COST

SMC1

LMC

The increase in price will make the industry profitable This will result

in entry of new firms The increased supply will drive the price down until profits are back to zero at P0

1

Increasing cost industry

 Suppose that the industry’s initial long-run equilibrium corresponds to price and output levels P0 and Q0,

 We have a increasing cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price P1 is greater than P0

Q 0

D0 D1P

Q Quantity

Long Run Supply Curve

INCREASING COST INDUSTRY

Decreasing cost industry

 Industry’s initial long-run equilibrium corresponds to price and output levels P0 and Q0, respectively

 An increase demand from D0 to D1 results in higher

equilibrium price and quantity

 The higher price makes the industry profitable Firms will be encouraged to enter the industry However, the entry of firms causes LAC to shift downwards

 We have a decreasing cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price P1 is less than P0

SAC1

Q 0

COST

SMC1

The initial increase in price will make the industry profitable

However, the entry of new firms will cause the LAC to decrease (shift downward) Equilibrium will be established at P1,Q1

P0

MR0

P1

MR1P’1

LAC1

Q0

Q1

D0 D1P

Q Quantity

Long Run Supply Curve

DECREASING COST INDUSTRY

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