In the name of Allah Almighty who is most beneficent and most

merciful

Asifa Rasheed K1F14MCOM0029Noor-ul-Ain K1F14MCOM0017Mustafa Hanif K1F14MCOM0008Abdul Wahhab K1F14MCOM0002Zain Anjum K1F14MCOM0021Asif Nawaz K1F14MCOM0005

Project Prepared by: (Team: Seekers)

Project of Managerial Economics

Perfect competition

Contents:  • Types of market

• Perfect competition introduction

• Characteristics• Assumptions

• Efficiency• Equilibrium of firm

• Short run• Long run

• Criticism• International trade

• U.S case study

Types of market:

Types of market

Market structures with respect to competition:

Introduction:

Perfect competition is a market structure where many firms offer a homogeneous product. Because there is freedom of entry and exit and perfect information, firms will make normal profits and prices will be kept low by competitive pressures.

Characteristics: Large number of buyers and sellers

Homogenous product

Free entry and exit of firms

Perfectly elastic demand

Perfect knowledge of consumers

Normal profits of firms

Price taker

No control over price

Perfect mobility of FOP

Characteristics(cont’d):

Assumptions:

Many suppliers (more than 100)

Price taker, significant market share , no affect on price through supply

Identical/perfect substitutes/standardized output

All firms have equal access to market

No barriers to entry & exit of firms

No super normal profit

Perfect information

Assumptions(cont’d):

Firm as price taker:The market price is where market demand is equal to market supply. All firms will charge this price.

MC

P=AR=MR

Output

x

y

Reven

ue &

cost

E

MC=MR

A

B

Q

P

Efficiency of firms:

Efficient i.e. P=MC, at equilibrium point

Productively efficient

Have to remain efficient, otherwise out of business

Dynamically inefficient, nothing to invest in R&D

Examples: Foreign exchange markets

Agricultural markets

Internet related industries

Equilibrium of firm under perfect competition:

Short run Long run

Conditions of equilibrium:

MC=MR MC must cut MR curve from below of it

MC

P=AR=MR

Output

x

yR

even

ue

& c

ost

E

MC=MR

A

B

Q

P

Diagram:

Short run equilibrium possibilities:

Abnormal/Supernormal profit

Normal profit

Normal loss

Abnormal loss/Shut down point

Equilibrium possibilities in

short run

Abnormal profit:

MC

P=AR=MR

Output

x

y

Reven

ue

& c

ost

MC=MR

Q

P

AC

CProfit

TR>TC

E

Normal profit:

P=AR=MR

Output

x

y

MC=MR

Q

P

ACTR=TC

E

MCR

even

ue

& c

ost

Why normal profit? When TR=TC

It means firm does not earn the profit above the estimated profit. As in Economics the estimated profit is added in cost so when it is said that TR=TC, that does not result in zero profit.

Normal loss:

MC

P=AR=MR

Output

x

y

Reven

ue &

cost

MC=MR

Q

P

ACTR<TC

EAVCLoss

Abnormal loss:

P=AR=MR

Output

x

y

MC=MR

Q

P

AC

E

MC

Reven

ue &

cost

AVC

Loss

Shut down point

On average normal profit in long run:

P=AR=MR

Output

x

y

MC=MR

Q

P

ACTR=TC

E

MC

Reven

ue &

cost

Criticism:

If all firms are price takers, who is price maker?

Very few markets or industries in the real world are perfectly competitive

How homogeneous is the output of real firms?

Differences between supply and demand cause changes in price, not true for short run.

International trade:

Exchange of goods and services between two countries.

oTariff

o Quota

Save domestic industry

Case study: U.S watches demand and supply

Qd & Qs

x

y

Pri

ce E

$15P

Q

U.S demand

U.S supply

15M

20M

25M

$12.50

<----------Imports------->

Free trade

Solution to problem:

If U.S government imposes a tariff (12%) then price will increase from $12.50 to $14.

12.50 x 12% = $1.5 + $12.50 = $14 (new price)

As a result the supply increases and the quantity demanded decreases. Now the U.S govt. will have to import only 4 Million of watches.

Diagram:

Qd & Qs

x

yP

rice E

$15P

Q

U.S demand

U.S supply

15M

20M

25M

$12.50

$14

18M

22M

<Imports>

Trying to do what your competitors are doing but basically a little bit better is probably not going to be the winning strategy. The problem is finding what your competitors wouldn't even consider doing.

Ending quote