PERFECT COMPETITION (OPTIMAL PRODUCTION IN A PERFECT COMPETITIVE MARKET)

PERFECT COMPETITIONPERFECT COMPETITION(OPTIMAL PRODUCTION IN A PERFECT (OPTIMAL PRODUCTION IN A PERFECT

COMPETITIVE MARKET)COMPETITIVE MARKET)

STUDY UNIT 9STUDY UNIT 9

PRESCRIBED BOOK CHAPTER PRESCRIBED BOOK CHAPTER 1212

2

SOME OF THE STUDY OBJECTIVESSOME OF THE STUDY OBJECTIVES

Define and indicate what the characteristics of a perfect Define and indicate what the characteristics of a perfect competitive market arecompetitive market are

Explain the demand curve of under perfect competitionExplain the demand curve of under perfect competition

Draw the demand curve for a single firm under perfect Draw the demand curve for a single firm under perfect competitioncompetition

Determine where profit is maximised in the short-termDetermine where profit is maximised in the short-term

Indicate whether a firm records economic profit, normal profit or Indicate whether a firm records economic profit, normal profit or an economic loss graphicallyan economic loss graphically

Determine the shut-down/open-up point.Determine the shut-down/open-up point.

3

CHARACTERISTICS OF A PERFECT CHARACTERISTICS OF A PERFECT COMPETITIVE MARKETCOMPETITIVE MARKET

DEFINITION: DEFINITION: Perfect competition occurs when Perfect competition occurs when nonenone of of

the the individualindividual market participants (buyers & sellers) market participants (buyers & sellers)

can influence the price of the product.can influence the price of the product.

-- They are price takers and quantity adjusters.They are price takers and quantity adjusters.

REQUIREMENTS:REQUIREMENTS:

Large number of buyers and sellersLarge number of buyers and sellers

No collusion between sellers – each one acts independentlyNo collusion between sellers – each one acts independently

Homogeneous (identical) product is soldHomogeneous (identical) product is sold

Freedom of exit and entry to the marketFreedom of exit and entry to the market

Perfect informationPerfect information

No government interventionNo government intervention

Production factors are mobileProduction factors are mobile

4

Individual demand curve for the firmIndividual demand curve for the firm

0

200

400

600

800

1000

1200

Quantity Market

Pri

ce

0

100

200

300

400

500

600

700

0 50 100 150 200

QUANTITY OF FIRM

PRIC

E

D

S

D=AR=MR=P

5Chapter 12 Perfect competition© Van Schaik Publishers

Figure 12-1 The demand curve for the product of the firm under perfect

competition

6

QuantityQuantity Price per Price per unit (R)unit (R)

TR = P x TR = P x QQ

MRMR ARAR

00 600600 00 00 00

5050 600600 30 00030 000 30 000 30 000 ÷ ÷ 5050

600600

600600

100100 600600 60 00060 000 30 000 30 000 ÷ ÷ 5050

600600

600600

150150 600600 90 00090 000 30 000 30 000 ÷ ÷ 5050

600600

600600

200200 600600 120 000120 000 30 000 30 000 ÷ ÷ 5050

600600

600600

250250 600600 150 000150 000 30 000 30 000 ÷ ÷ 5050

600600

600600

7

PROFIT POSITION IN THE SHORT-TERMPROFIT POSITION IN THE SHORT-TERM

Determine profit in short-term according toDetermine profit in short-term according to::

Total approach (not prescribed) Total approach (not prescribed) - Firm produces where profit (TR – - Firm produces where profit (TR –

TC) is the highestTC) is the highest

Shut-down (start-up) rule (prescribed book p 227) Shut-down (start-up) rule (prescribed book p 227) – Revenue: – Revenue:

TR = or greater than TVC; Unit Costs: AR (p) = or greater than AVCTR = or greater than TVC; Unit Costs: AR (p) = or greater than AVC

Marginal Approach (the profit-maximising rule)Marginal Approach (the profit-maximising rule)

MR = MCMR = MC

Differentiate between:Differentiate between:

Economic profitEconomic profit

Normal ProfitNormal Profit

Economic lossEconomic loss

8

TOTAL APPROACHTOTAL APPROACH

QUANTITYQUANTITY PRICEPRICE TRTR TCTC PROFITPROFIT

00 66 00 33 -3-3

11 66 66 55 11

22 66 1212 88 44

33 66 1818 1212 66

44 66 2424 1717 77

55 66 3030 2323 77

66 66 3636 3030 66

77 66 4242 3838 44

88 66 4848 4747 11

99 66 5454 5959 -5-5


Box 12-3Marginal cost and profit maximisation

10

MARGINAL APPROACHMARGINAL APPROACH

QQ PP TRTR MRMR TCTC MCMC ACAC PROFITPROFIT

00 66 00 00 33 00 00 -3-3

11 66 66 66 55 22 55 11

22 66 1212 66 88 33 44 44

33 66 1818 66 1212 44 44 66

44 66 2424 66 1717 55 4,254,25 77

5 6 30 6 23 6 4,60 7

66 66 3636 66 3030 77 55 66

77 66 4242 66 3838 88 5,435,43 44

88 66 4848 66 4747 99 5,885,88 11

99 66 5454 66 5959 1212 6,556,55 -5-5

1010 66 6060 66 7373 1414 7,307,30 -13-13

11

MARGINAL APPROACH GRAPHICALLYMARGINAL APPROACH GRAPHICALLY

0

2

4

6

8

10

12

0 1 2 3 4 5 6 7 8 9 10

QUANTITY

PR

ICE

, M

R,M

C

MC

MR = PProfit

increases

MR>MC

Profit

decreases

MC>MRProfit maximised MR=MC


Figure 12-5 Marginal revenue and marginal cost of a firm operating in a perfectly competitive

market

13

PROFIT AND LOSS POSITIONSPROFIT AND LOSS POSITIONS

Economic profit:Economic profit: P > minimum of ACP > minimum of AC TR > TCTR > TC MR > MCMR > MC

Normal ProfitNormal Profit P = minimum of ACP = minimum of AC TR = TCTR = TC MR = MCMR = MC

Economic lossEconomic loss P < minimum of ACP < minimum of AC TR < TCTR < TC MR < MC MR < MC

Market supply curve –figure 12.7 (see later)Market supply curve –figure 12.7 (see later)

14

SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC PROFITTHE FIRM – AN ECONOMIC PROFIT

0

1

2

3

4

5

6

7

0 1 2 3 4 5 6 7 8 9 10

QUANTITY

PR

ICE

, MR

,MC

MC

MR = P

ACE

M

15

SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – NORMAL PROFITTHE FIRM – NORMAL PROFIT

0

1

2

3

4

5

6

7

0 1 2 3 4 5 6 7 8 9 10

QUANTITY

PR

ICE

, MR

,MC

MC

MR = P

AC

E

16

SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC LOSSTHE FIRM – AN ECONOMIC LOSS

0

1

2

3

4

5

6

7

0 1 2 3 4 5 6 7 8 9 10

QUANTITY

PR

ICE

, MR

,MC

MC

MR = P

AC

E

M


Figure 12-6 Different possible short-run equilibrium positions of the firm under

perfect competition

18

THE FIRM’S SUPPLY CURVETHE FIRM’S SUPPLY CURVE

Cost, Price (Rand)

Output/day

MC AC

AVC

8.0

12.0

Price 20.0

60 80 100

A

B

C


Figure 12-7 The supply curve of the firm

20

CHANGES IN THE LONG RUN IF THE FIRM RECORDS AN ECONOMIC PROFIT IN SHORT

RUN

0

200

400

600

800

1000

1200

1400

1600

0 100 200 300 400 500 6000

200

400

600

800

1000

1200

1400

0 100 200 300 400 500 600

MC

AC

MR

MR1

E

E1

DS

S1

E

E1

21

CHANGES IN THE LONG RUN IF THE FIRM RECORDS AN ECONOMIC LOSS IN SHORT

RUN

0

200

400

600

800

1000

1200

1400

1600

0 100 200 300 400 500 6000

200

400

600

800

1000

1200

1400

0 100 200 300 400 500 600

MC

AC

MR

MR1

E

E1

D

S

S1

E

E1

22

D S

D

Market Firm

EXPLAIN WHY UNDER PERFECT COMPETITION THE INDIVIDUAL FIRM IS FACED BY A PERFECT ELASTIC DEMAND CURVE

23

DRAW A GRAPH THAT INDICATES WHERE THE PERFECT COMPETITIVE FIRM IS MAKING NORMAL PROFIT IN THE SHORT RUN.

24

SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – NORMAL PROFITTHE FIRM – NORMAL PROFIT

0

1

2

3

4

5

6

7

0 1 2 3 4 5 6 7 8 9 10

QUANTITY

PR

ICE

, MR

,MC

MC

MR = P

AC

E

25

EXAM QUESTIONS SHORT-RUN EQUILIBRIUMEXAM QUESTIONS SHORT-RUN EQUILIBRIUM

0

200

400

600

800

1000

1200

0 Q1 Q2 Q3 Q4 Q5

QUANTITY

PR

ICE

H

G

K

C

A

26

QUESTION RELATING TO SLIDE 25QUESTION RELATING TO SLIDE 25

Curve H represents which curve?Curve H represents which curve?

Name curve K? Name curve K?

At which quantity is profit maximised?At which quantity is profit maximised?

What does the price line represent?What does the price line represent?

The short-run supply curve of the firm is from?The short-run supply curve of the firm is from?

Is this firm earning an economic profit, normal profit or Is this firm earning an economic profit, normal profit or economic loss?economic loss?

What does the vertical distance between curve H and G What does the vertical distance between curve H and G represent?represent?

27

SHORT-RUN EQUILIBRIUMSHORT-RUN EQUILIBRIUM

0

0.2

0.4

0.6

0.8

1

1.2

0 Q1 Q2 Q3 Q4 Q5

QUANTITY

PR

ICE

28

QUESTION RELATING TO SLIDE 27QUESTION RELATING TO SLIDE 27

Name the 2 curves?Name the 2 curves?

Illustrate an economic loss on the graph with the aid of a Illustrate an economic loss on the graph with the aid of a shaded area?shaded area?

29

SHORT TERM EQUILIBRIUM POSITIONS OF SHORT TERM EQUILIBRIUM POSITIONS OF THE FIRM – AN ECONOMIC LOSSTHE FIRM – AN ECONOMIC LOSS

AC

E

M

30

Examination questionsExamination questions

What is the profit maximising rule for the firm in a perfectly What is the profit maximising rule for the firm in a perfectly competitive market which applies the marginal approach?competitive market which applies the marginal approach?

When will a firm increase production according to the When will a firm increase production according to the marginal approach?marginal approach?

When will a firm reduce its production using the marginal When will a firm reduce its production using the marginal approach?approach?

31

THE FIRM’S SUPPLY CURVETHE FIRM’S SUPPLY CURVE

Cost, Price (Rand)

Output/day

MC AC

AVC

8.0

12.0

Price 20.0

60 80 100

A

B

C

32

Questions Relating to slide 31 Questions Relating to slide 31

What is the firm's profit-maximising daily output? What is the total daily revenue of the profit-maximising

firm? Total daily costs to the firm is? At which price will it be immaterial for the firm if it shuts

down or continues production? At what point will the firm minimize its economic loss?

What will the firm earn at a price of R20? Briefly explain

why? Briefly explain the concept break even. Also indicate at

which corresponding point on the figure this situation will occur.

33

Questions Relating to slide 31 Questions Relating to slide 31

The vertical distance between AC and AVC represents?

What part of the firm's MC curve can be regarded as

the firm's supply curve?

Documents

PERFECT COMPETITION (OPTIMAL PRODUCTION IN A PERFECT COMPETITIVE MARKET)