LaytonIM Ch07
LaytonIM Ch07
LaytonIM Ch07
Perfect competition
Chapter summary
There are three characteristics of perfect competition:
• large number of sellers
• firms sell a homogenous product
• there are virtually no barriers to entry or exit.
In addition, firms are price takers.
Like all firms, the competitive firm is assumed to attempt to maximise profits. This can
be achieved either through the total revenue–total cost method, or the marginal revenue equals
marginal cost method. When output is produced at which marginal revenue equals marginal
cost, the firm will be maximising its profit, if a profit is being made. If losses are incurred, then
it will be minimising its losses. The shut-down rule is where price (marginal revenue) is less
than average variable cost.
A competitive firm’s short-run supply curve is its MC curve above minimum AVC. The
industry’s short-run supply curve is the horizontal summation of all firms’ short-run MC curves
above the minimum AVC.
In the short run, a competitive firm may earn either make economic profits, zero
economic profits (only a normal profit), or incur losses. However, in the long run (over time),
only normal profits can be made because of the lack of barriers to entry and exit. Long-run
competitive equilibrium occurs when the firm earns a normal profit by producing where price
equals minimum long-run average cost equals minimum short-run average cost equals short-run
marginal cost.
The three possible perfectly competitive industry long-run supply curves depend on
whether a constant-cost, decreasing-cost, or increasing-cost industry is experienced.
Instructional objectives
After completing this chapter, students should be able to:
• describe the characteristics of perfect competition
• graphically express the competitive firm’s demand curve and understand that this curve
reflects the fact that the competitive firm is a price taker
• graphically find the profit maximising quantity to produce and explain why this output is the
profit maximising quantity
• graphically determine the area representing any economic profits or losses
• find on a graph the competitive firm’s short-run supply curve and explain why this is the
case
• derive the industry’s short-run supply curve
• explain what is expected to happen over time, given short-run economic profits or losses
and express this graphically
• graphically illustrate long-run equilibrium for a competitive industry and explain why this is
the case
• explain what can cause the three possible perfectly competitive industry’s long-run supply
curves to be observed.
Chapter 7 outline
Introduction
Market structures
Perfect competition
Large number of small firms
Exhibit 7.1 Comparison of market structures
Homogeneous product
Very easy entry and exit
The perfectly competitive firm as a price taker
Exhibit 7.2 The market price and demand for the perfectly competitive firm
Short-run profit maximisation for a perfectly competitive firm
The total revenue–total cost method
Exhibit 7.3 Short-run profit maximisation schedule for Atmach as a perfectly
competitive firm
The marginal revenue equals marginal cost method
Exhibit 7.4 Short-run profit maximisation using the total revenue-total cost
method
Exhibit 7.5 Short-run profit maximisation using the marginal revenue equals
marginal cost method
Short-run loss minimisation for a perfectly competitive firm
A perfectly competitive firm facing a short-run loss
Exhibit 7.6 Short-run loss minimisation
A perfectly competitive firm shutting down
Exhibit 7.7 The short-run shutdown point
Short-run supply curves under perfect competition
You make the call: Should motels offer rooms at the beach for only $40 a night?
The perfectly competitive firm’s short-run supply curve
Doing all of this for each market structure will allow students to compare and contrast the
four market structures.
5 Emphasise to students that the profit-maximising criteria is where MR=MC.
6 Other ways to explain the shut-down rule (in addition to that stated in the text: if P (MR) <
AVC):
a if losses are greater than total fixed cost
b if total revenue is less than total variable cost.
It is intuitive, if one keeps in mind that when a firm shuts down its losses will equal TFC. If
one remains in operation and loses more than their TFC, then one should naturally shut
down and lose less.
7 Have students note that because there are no barriers to entry or exit, then any profits or
losses experienced in the short run will disappear in the long run (over time). Entrepreneurs
will continue to enter or leave an industry until only normal profits can only be made.
8 You may find it helpful to take a few minutes to stress the pros and cons associated with the
competitive market from society’s perspective:
a P = minimum ATC implies no contribution toward a more inequitable distribution of
income as well as consumers getting the product at the cheapest possible price
b P = MC implies an efficient allocation of resources, etc
c Homogenous product indicates lack of variety.
INDUSTRY FIRM
Price ($)
Supply
2 D = MR
Dd=MR
Demand
5 Figure 8A-2 presents the information graphically. Marginal revenue is the change in total
revenue as a result of a change in quantity (kilos). In this case, $5 is the marginal revenue
that remains constant and equal to price. Note the point at which D = MR = TR.
Figure 8A-2
Multiple-choice solutions
(pp 204–6)
1b a great variety of different products
2b homogeneous products
3b price and marginal revenue
4b $100
5c marginal revenue
6d shut down
7b average variable cost curve
8d 2000 units per week
9b $10 per unit
10b stay in operation for the time being even though it is earning an economic loss
11c less than $10 000 per week
12d all of the total fixed costs and total variable costs
13b B to D and all points above
14d all of the above
15d firms enter and exit the industry
16a an increasing-cost industry
17d all of the above are true.