Perfect Competition

PERFECT COMPETITION
SHORT RUN AND LONG RUN
2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
OSullivan & Sheffrin
Definition
A perfect competitive market is one in
Which economic forces operate

unimpeted
Features of a Perfectly Competitive

Market
1. There are many firms.
2. The product is standardized, or
homogeneous.
3. Firms can freely enter or leave the
market in the long run.
4. Each firm takes the market price as
given.
The Short-run Output Decision
The firms objective is to produce the

level of output that will maximize profit.
Economic profit = total revenue minus

total economic cost.
Total revenue = price x quantity sold.

The cost structure of the business firm is
the same as the one we studied earlier.
The Firms Total Cost Structure

(Reviewed)
The shape of the total cost
curve comes from
diminishing returns in the
short run.
STC TFC STVC

Short-run
Total Cost
Total Fixed
= Cost
Short-run
Total Variable
Cost
Output:
Rakes per
Minute
Total
Sho
Fixed Variable Short-run Ma
Cost
Cost
Total Cost
C
Q
0
1
2
3
4
5
6
7
8
9
10
FC
36
36
36
36
36
36
36
36
36
36
36
TVC
0
8
12
15
20
27
36
48
65
90
130
STC
36
44
48
51
56
63
72
84
101
126
166
The Revenue Structure of the

Competitive Business Firm
The perfectly competitive firm is a

price-taking firm. This means that the
firm takes the price from the market.
As long as the market remains in
equilibrium, the firm faces only one
pricethe equilibrium market price.
Computing the Total Revenue of a

Price-taker
Q
0
1
2
3
4
5
6
7
8
9
10
Price ($)
P
25
25
25
25
25
25
25
25
25
25
25
Total
Revenue
($)
TR
0.00
25.00
50.00
75.00
100.00
125.00
150.00
175.00
200.00
225.00
250.00
200
C o s t in $
Output:
Rakes per
Minute
Total Revenue
250
150
100
50
0
0
10
Output: Rakes per minute
Since the perfectly competitive firm

faces a constant price, the shape of
its total revenue is an upward-sloping
line. Total revenue changes only with
changes in the quantity sold.
The Totals Approach to Profit

Maximization
To maximize profit, a producer

finds the largest gap between
total revenue and total cost.
Output:
Rakes per
Minute
Total
Revenue
($)
Short-run
Total Cost
Profit
Q
0
1
2
3
4
5
6
7
8
9
10
TR
0.00
25.00
50.00
75.00
100.00
125.00
150.00
175.00
200.00
225.00
250.00
STC
36
44
48
51
56
63
72
84
101
126
166
-36
-19
2
24
44
62
78
91
99
99
84
The Marginal Approach
The other way to decide how much

output to produce involves the marginal
principle.
Marginal PRINCIPLE
Increase the level of an activity if its marginal benefit
exceeds its marginal cost, but reduce the level if the
marginal cost exceeds the marginal benefit. If
possible, pick the level at which the marginal benefit
equals the marginal cost.
Marginal Revenue
The benefit of producing and selling

rakes is the revenue the firm collects.
If the firm sells one more rake, total
revenue increases by $25.
Marginal benefit = marginal revenue =
market price
The Marginal Rule for Profit

Maximization
A firm maximizes profit

in accordance with the
marginal principleby
setting marginal
revenue (or market
price) equal to
marginal cost.
Output:
Marginal
Rakes per Revenue =
Minute
Price ($)
Q
0
1
2
3
4
5
6
7
8
9
10
P
25
25
25
25
25
25
25
25
25
25
25
Short-run
Marginal
Cost
Profit
SMC
8
4
3
5
7
9
12
17
25
40
-36
-19
2
24
44
62
78
91
99
99
84
Ou
Rak
M
Profit Maximization Using the

Marginal Approach
Economic Profit
Profit per unit equals

revenue per unit (or
price) minus cost per
unit (or average total
cost).
($25 - $14) = 11
Total economic profit

equals:
(price average cost)
x quantity produced
($25 - $14) x 9 = $99
Short-run Supply Curve
The firms short-run supply

curve shows the relationship
between the market price and the
quantity supplied by the firm over
a period of time during which one
inputthe production facility
cannot be changed.
Short-run Supply Curve
The short-run supply curve is

the firms SMC curve rising
above the minimum point on the
SAVC curve.
For any price above

the shut-down price,
the firm adjusts
output along its
marginal cost curve
as the price level
changes.
Below the shut-down

price, quantity
supplied equals zero.
The Market Supply Curve
The short-run market supply curve shows the relationship between

the market price and the quantity supplied by all firms in the short
run.
A Market in Long-run Equilibrium

A market reaches a long-run equilibrium when three
conditions hold:
1. The quantity of the product supplied equals the
quantity demanded
2. Each firm in the market maximizes its profit, given the
market price
3. Each firm in the market earns zero economic profit,
so there is no incentive for other firms to enter the

market
In short-run equilibrium, quantity

supplied equals quantity demanded
and each firm in the market maximizes
profit.
In addition to the conditions above, in
long-run equilibrium the typical firm
earns zero economic profit so there is
no further incentive for firms to enter
the market.
In long-run equilibrium, price equals marginal cost

(the profit-maximizing rule), and price equals shortrun average total cost (zero economic profit).
The Long-run Supply Curve for an

Increasing-cost Industry
An increasing-cost industry is an industry

in which the average cost of production
increases as the total output of the industry
increases.
The average cost increases as the industry

grows for two reasons:
Increasing input prices
Less productive inputs
Industry Output and Average

Production Cost
Number of
Firms
Industry
Output
Rakes per
Firm
Typical
Cost for
Typical
Firm
50
350
$70
$10
100
700
84
12
150
1,050
96
14
Average
Cost per
Rake
The rake industry is an increasing-cost industry because

the average cost of production increases as the total
output of the industry increases.
The Long-run Effects of an Increase

in Demand
In the long run, after

new firms enter,
equilibrium settles at
$14.
The new price is a
higher price than the
price before the
increase in demand
(increasing cost
industry).
Long-run Supply Curve for an

Constant-cost Industry
In a constant-cost industry, firms

continue to buy inputs at the same prices.
The long-run supply curve is horizontal at

the constant average cost of production.
After the industry expands, the industry

settles at the same long-run equilibrium
price as before.

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What are the features of a perfectly competitive market?

What are the features of a perfectly competitive market?

How does a firm determine its profit-maximizing output level in the short run?

How does a firm determine its profit-maximizing output level in the short run?

PERFECT COMPETITION

SHORT RUN AND LONG RUN

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

A perfect competitive market is one in

Which economic forces operate

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

Features of a Perfectly Competitive

3. Firms can freely enter or leave the

market in the long run.

4. Each firm takes the market price as

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

The Short-run Output Decision

The firms objective is to produce the

Economic profit = total revenue minus

Total revenue = price x quantity sold.

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

The Firms Total Cost Structure

STC TFC STVC

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

The Revenue Structure of the

The perfectly competitive firm is a

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

Computing the Total Revenue of a

2001 Prentice Hall Business Publishing

Output: Rakes per minute

Since the perfectly competitive firm

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

The Totals Approach to Profit

To maximize profit, a producer

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

The Marginal Approach

The other way to decide how much

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

The benefit of producing and selling

2001 Prentice Hall Business Publishing

Economics: Principles and Tools, 2/e

OSullivan & Sheffrin

The Marginal Rule for Profit

A firm maximizes profit