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PERFECT COMPETITION
Lecture
The Four Types of Market Structure
Monopoly Oligopoly Monopolistic
Competition
Perfect Competitio
n
• Tap water• Cable TV
• Tennis balls• Crude oil
• Novels• Movies
• Wheat• Milk
Number of Firms?
Type of Products?
Many firms
One
firm Few
firm
sDifferentiated
productsIdentical products
Pure MonopolySingle sellerNo close substitutesPrice MakerBlocked EntryExample: Electricity
Monopolistic Competition Relatively large number of
sellers Differentiated products Easy entry and Exit Example: Furniture, Clothing
Oligopoly
A few large producerHomogenous or differentiated products
Control over price but mutual interdependence
Entry BarriersExample: Mobile phone operators, Air lines, automobiles, computers
Duopoly Two Producers Identical Products Barriers to entry Example: SNGPL Sui Northern Gas
Pipelines Limited.
Pure Competition
Very Large NumbersStandardized Product“Price Takers”Free Entry and Exit Examples: Wheat or peanuts
Firm’sDemandSchedule(AverageRevenue)
Firm’sRevenue
Data
Pure Competition
Pric
e an
d Re
venu
e
2 4 6 8 10 12
131
262
393
524
655
786
917
1048
$1179
Quantity Demanded (Sold)
P = MR = AR
TR
P QD TR MR
$131131131131131131131131131131131
0123456789
10
$0131262393524655786917
104811791310
$131131131131131131131131131131
]]]]]]]]]]
Total Revenue-Total Cost Approach
Profit Maximization in the Short Run
(1)Total Product(Output) (Q)
(2)Total FixedCost (TFC)
(3)Total Variable
Cost (TVC)
(4)Total Cost
(TC)
(5)Total Revenue
(TR)
(6)Profit (+)or Loss (-)
Price = $131
0123456789
10
$100100100100100100100100100100100
$090
170240300370450540650780930
$100190270340400470550640750880
1030
$0131262393524655786917
104811791310
$-100-59-8
+53+124+185+236+277+298+299+280
Now Let’s Graph The Results…Do You See Profit Maximization?
Marginal Revenue-Marginal Cost Approach MR = MC Rule
Profit Maximization in the Short Run
Important Features:• Firm Will Shut Down Unless MR at Least Meets MC
• Profit Maximization in All Market Structures
• Can Be Restated P = MC
Cost
and
Rev
enue
$200
150
100
50
0 1 2 3 4 5 6 7 8 9 10Output
Economic Profit
Marginal Revenue-Marginal Cost Approach MR = MC Rule
Profit Maximization in the Short Run
MR = P
MCMR = MC
AVCATC
P=$131
A=$97.78
Lower the Price to $81 andObserve the Results!
Cost
and
Rev
enue
$200
150
100
50
0 1 2 3 4 5 6 7 8 9 10Output
Loss
Marginal Revenue-Marginal Cost Approach MR = MC Rule
Profit Maximization in the Short Run
MR = P
MC
AVCATC
Loss Minimizing Case
P=$81
A=$91.67
V = $75
Lower the Price Further to $71 and Observe the Results!
Cost
and
Rev
enue
$200
150
100
50
0 1 2 3 4 5 6 7 8 9 10Output
Marginal Revenue-Marginal Cost Approach MR = MC Rule
Profit Maximization in the Short Run
MR = P
MC
AVC
ATC
Short-Run Shut Down Case
P=$71 Short-Run Shut Down PointP < Minimum AVC
$71 < $74
V = $74
The Marginal Revenue and Marginal Cost Approach
Firm should continue to increase output as long as marginal revenue > marginal cost
Remember that profit-maximizing output is found where MC curve crosses MR curve from below
Finding the profit-maximizing output level for a competitive firm requires no new concepts or techniques
Measuring Total Profit Start with firm’s profit per unit
Revenue =TR-TC Firm earns a profit whenever P > ATC A firm suffers a loss whenever P <
ATC at the best level of output
The Firm’s Short-Run Supply Curve
A competitive firm is a price taker Takes market price as given and
then decides how much output it will produce at that price
Competitive Markets in the Short- Run
Short-run is a time period too short for firm to vary all of its inputs Quantity of at least one input remains
fixed Let’s extend concept of short-run from
firm to market as a whole Conclusion
In short-run, number of firms in industry is fixed
Profit and Loss and the Long Run In a competitive market, economic profit and loss
are the forces driving long-run change Expectation of continued economic profit (losses) causes
outsiders (insiders) to enter (exit) the market In real world entry and exit occur literally every day
In some cases, we see entry occur through formation of an entirely new firm
Entry can also occur when an existing firm adds a new product to its line
Exit can occur in different ways Firm may go out of business entirely, selling off its assets
and freeing itself once and for all from all costs Firm switches out of a particular product line, even as it
continues to produce other things
Market Signals and the Economy In real world, demand curves for different goods
and services are constantly shifting As demand increases or decreases in a market,
prices change Economy is driven to produce whatever collection
of goods consumers prefer In a market economy, price changes act as market
signals, ensuring that pattern of production matches pattern of consumer demands When demand increases, a rise in price signals firms to
enter market, increasing industry output When demand decreases, a fall in price signals firms to
exit market, decreasing industry output
Market Signals and the Economy Market signal
Price changes that cause firms to change their production to more closely match consumer demand
No single person or government agency directs this process This is what Adam Smith meant when he
suggested that individual decision makers act for the overall benefit of society Even though, as individuals, they are merely trying to
satisfy their own desires As if guided by an invisible hand
Characteristic Pure competition
Monopolistic competition
Oligopoly Pure Monopoly
# of firms Large number
many few one
Type of product
Standardized Differentiated Standardized &Differentiated
Unique ;no close substitute
Control over price
none Some, but within rather narrow limits
Mutual decision
considerable
Conditions of entry
Very easy, free
Relatively easy
Significant obstacles
Blocked
Non price competition
None Brand names, trade marks
Typically a great deal
Advertising, public relations
Examples Agriculture Retail trade, dresses,shoes
Steel, automobiles, farm implements, many household appliances
Local Utilities
