Perfect Perfect CompetitionCompetition

Chapter 11

A Perfectly A Perfectly Competitive MarketCompetitive Market

• A perfectly competitive market is one in which economic forces operate unimpeded.

A Perfectly A Perfectly Competitive MarketCompetitive Market

• A perfectly competitive market must meet the following requirements:

Both buyers and sellers are price takers.

The number of firms is large. There are no barriers to entry. The firms’ products are identical. There is complete information. Firms are profit maximizers.

The Necessary The Necessary Conditions for Perfect Conditions for Perfect

CompetitionCompetition• Both buyers and sellers are price takers.

o A price taker is a firm or individual who takes the market price as given.

o In most markets, households are price takers – they accept the price offered in stores.

Market supply

Marketdemand

1,000 3,000

Price$10

8

6

4

2

0Quantity

Market Firm

Individual firm demand

Market Demand Versus Market Demand Versus

Individual Firm Demand CurveIndividual Firm Demand Curve

10 20 30

Price$10

8

6

4

2

0Quantity

Profit-Maximizing Profit-Maximizing Level of OutputLevel of Output

• The goal of the firm is to maximize profits.• Profit is the difference between total revenue and

total cost.

Profit-Maximizing Profit-Maximizing Level of OutputLevel of Output

• What happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC).

A firm maximizes profit when MC = MR.

Profit-Maximizing Profit-Maximizing Level of OutputLevel of Output

• Marginal revenue (MR) – the change in total revenue associated with a change in quantity.

Marginal cost (MC) – the change in total cost associated with a change in quantity.

Marginal RevenueMarginal Revenue• A perfect competitor accepts the market price as

given.• As a result, marginal revenue equals price (MR =

P).

Marginal CostMarginal Cost• Initially, marginal cost falls and then begins to

rise.• Marginal concepts are best defined between the

numbers.

Profit Maximization: Profit Maximization: MC = MRMC = MR• To maximize profits, a firm should produce where

marginal cost equals marginal revenue.

How to Maximize How to Maximize ProfitProfit

• If marginal revenue does not equal marginal cost, a firm can increase profit by changing output.

• The supplier will continue to produce as long as marginal cost is less than marginal revenue.

How to Maximize How to Maximize ProfitProfit

• The supplier will cut back on production if marginal cost is greater than marginal revenue.

Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.

The Marginal Cost The Marginal Cost Curve Is the Supply Curve Is the Supply

CurveCurve• The marginal cost curve is the firm's supply curve

above the point where price exceeds average variable cost.

The Marginal Cost The Marginal Cost Curve Is the Supply Curve Is the Supply

CurveCurve• The MC curve tells the competitive firm how

much it should produce at a given price.

The firm can do no better than produce the quantity at which marginal cost equals marginal revenue which in turn equals price.

The Marginal Cost The Marginal Cost Curve Is the Firm’s Curve Is the Firm’s

Supply CurveSupply Curve

A

B

CMarginal cost

Cos

t, P

rice

$70

60

50

40

30

20

10

0 1 Quantity2 3 4 5 6 7 8 9 10

Profit Maximization Profit Maximization Using Total Revenue Using Total Revenue

and Total Costand Total Cost• Profit is maximized where the vertical distance

between total revenue and total cost is greatest.• At that output, MR (the slope of the total revenue

curve) and MC (the slope of the total cost curve) are equal.

TC TR

0

Tot

al c

ost,

rev

enue

$385350315280245210175140105

7035

Quantity1 2 3 4 5 6 7 8 9

Profit Determination Using Profit Determination Using

Total Cost and Revenue Total Cost and Revenue

CurvesCurves

Maximum profit =$81

$130

Loss

Loss

Profit

Profit =$45

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Total Profit at the Total Profit at the Profit-Maximizing Profit-Maximizing Level of OutputLevel of Output

• The P = MR = MC condition tells us how much output a competitive firm should produce to maximize profit.

• It does not tell us how much profit the firm makes.

Determining Profit and Determining Profit and Loss From a Table of Loss From a Table of

CostsCosts• Profit can be calculated from a table of costs and

revenues.• Profit is determined by total revenue minus total

cost.

Determining Profit and Determining Profit and Loss From a GraphLoss From a Graph

• Find output where MC = MR.o The intersection of MC = MR (P) determines the quantity the firm will

produce if it wishes to maximize profits.

Determining Profit and Determining Profit and Loss From a GraphLoss From a Graph

• The firm makes a profit when the ATC curve is below the MR curve.

The firm incurs a loss when the ATC curve is above the MR curve.

Determining Profit and Loss Determining Profit and Loss

From a GraphFrom a Graph• Zero profit or loss where MC=MR.

Firms can earn zero profit or even a loss where MC = MR.

Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.

(a) Profit case (b) Zero profit case (c) Loss case

Determining Profits Determining Profits GraphicallyGraphically

Quantity Quantity Quantity

Price65 60 55 50 45 40 35 30 25 20 15 10

5 0

65 60 55 50 45 40 35 30 25 20 15 10

5 01 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12

D

MC

A P = MR

B ATCAVC

E

Profit

C

MC

ATC

AVC

MC

ATC

AVC

Loss

65 60 55 50 45 40 35 30 25 20 15 10

5 0 1 2 3 4 5 6 7 8 910 12

P = MRP = MR

Price Price

© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill

The Shutdown PointThe Shutdown Point• The firm will shut down if it cannot cover average

variable costs. o A firm should continue to produce as long as price is greater than

average variable cost.o If price falls below that point it makes sense to shut down temporarily

and save the variable costs.

The Shutdown PointThe Shutdown Point• The shutdown point is the point at which the

firm will be better off it it shuts down than it will if it stays in business.

MC

P = MR

2 4 6 8 Quantity

Price

60

50

40

30

20

10

0

ATC

AVC

Loss

A$17.80

The Shutdown The Shutdown DecisionDecision

Short-Run Market Short-Run Market Supply and DemandSupply and Demand

• While the firm's demand curve is perfectly elastic, the industry's is downward sloping.

• For the industry's supply curve we use a market supply curve.

Adjustment from the Adjustment from the Long Run to the Short Long Run to the Short

RunRun• Industry supply and demand curves come

together to lead to long-run equilibrium.

An Increase in An Increase in DemandDemand

• The original firms return to their original output but since there are more firms in the market, the total market output increases.

• An increase in demand leads to higher prices and higher profits.o Existing firms increase output.o New firms enter the market, increasing output still more.o Price falls until all profit is competed away.

Profit$9

10120

FirmPrice

Quantity

B

A

Market Response to Market Response to an Increase in an Increase in

DemandDemandMarket

Quantity

Price

0

B

A

C

MC

AC

SLR

S0SR

D0

7

700

$9

8401,200

D1

S1SR

7

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

An Example in the Pakistani An Example in the Pakistani

Market of Perfect CompetitionMarket of Perfect Competition• Pakistan has a huge potential for telecom growth• Pakistan was ranked as a key destination for

telecom growth• Telecommunication sector has characteristic of

perfect competition :o Large number of buyers and sellerso Free entry and exito Knowledge of the product among the people

• Due to increased competition between 5 major companies – price is of a lesser competition compared to service and features

An Example in the Pakistani An Example in the Pakistani

Market of Perfect CompetitionMarket of Perfect Competition• In the beginning due to high tax on purchase of

SIM cards – the market was slow• When these taxes were lifted, the market started

to grow rapidly and more investments poured in• Together the internet service industry is also on

the rise which has attracted investors as well

Market ShareMarket Shareof Cellular Companiesof Cellular Companies

Change / Increase in SubscribersChange / Increase in Subscribers

Change in December – 2010Change in December – 2010

ConclusionConclusion• Zong capturing a greater market share by

promotion cheap calls throughout Karachi – “ Apna Karachi” package.

• Zong has gained a great share. • Zong and Ufone were head to head in 3rd Quarter

last year – (Ufone is the 2nd largest company)

• All this data shows that the market is free, larger number of sellers and buyers and all firms are price takers.

Example # 2Example # 2PAKISTAN DAIRY INDUSTRY

•Pakistan is 3rd largest producer in the world•On average 33.6 Billion liters produced country wide•15-19% is wasted due to spoiling•Total contribution to economy – Rs.540 Billion•97% of the economic activity is non-documented•Most of the producers are mixed farmers while very few are producing independently

Recommendations:•More transactions should be well documented for government to generate revenue•Government in return can provide facilities and job opportunities can be created•Boosting productivity can reduce imports – and more free market mechanism can be maintained•More imports and lesser exports can increase job opportunities•Technological advances can create more jobs•Lesser technological advances lead to spoiling of mik•More technological advances can increase job and investing opportunities

• Better factors of production and proper balance between labor and machinery can not only increase productivity but also increase other opportunities for job and investment. Which includes:

• Animal caring• Herd manager• Equipment Contractor• Equipment maintenance services• Milkmen services• Milk tank and storage services• Barn construction services• Animal feeding services