Perfect Comptt
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Transcript of Perfect Comptt
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Perfect
Competition
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Perfect Competition
It is that market structure in which a
large number of sellers and buyersmature their transactions. The productare homogeneous.
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Assumptions
There are many sellers and many buyers.
The products sold by the firms are identical(Homogeneous).
Entry into and exit from the market are easy,
No single firm can change the price of
product Buyers (consumers) and sellers (firms) haveperfect information
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Equilibrium Conditions
There are two equilibrium conditions
marginal revenue (MR) must beequal to marginal cost (MC).
Slope of Marginal Revenue must be
less than Slope of Marginal Cost
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Profit-Maximizing Level ofOutput Marginal revenue (MR) the change
in total revenue associated with achange in quantity.
Marginal cost(MC) the change in totalcost associated with a change in quantity.
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Marginal Revenue
TR =P*Q
MR = dTR/dQ AR = TR/Q or P*Q/Q OR AR= P
So if Price does not change then there
would be no change in MR .In short P=AR=MR
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According to theassumption, ifprice remains
same then MRand AR wouldalso equal toPrice
P Q TR MR AR
10 1 10 10 10
10 2 20 10 10
10 3 30 10 10
10 4 40 10 1010 5 50 10 10
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Profit Maximization: MC = MR
To maximize profits, a firm should
produce where marginal cost equalsmarginal revenue.
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How to Maximize Profit
The supplier will cut back on production
if marginal cost is greater than marginalrevenue.
Thus, the profit-maximizing condition of a
competitive firm is MC = MR = P.
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Possibilities of Profit and lossin Perfect Competition
There are four possibilities in Short run
Normal profit AR =AC
Normal Loss AR < AC
Abnormal Profit AR >> AC
Abnormal Loss AR
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C
A
P = AR =
MR
Costs
12 3 4 5 6 78 910Quantity
60
5040
30
2010
0
A
B
MC
Marginal Cost, Marginal
Revenue, and Price
0
123456789
10
$28.0020.0016.0014.0012.0017.00
22.0030.0040.0054.0068.00
Price = MRQuantityProduce
d
Marginal
Cost$35.00
35.0035.0035.0035.0035.0035.0035.0035.0035.0035.00
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., AllRights Reserved.
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Profit Maximization
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Profit Maximization: The
Numbers
Q P TR TC TR-TC MR MC ATC
0 $1 $0 $1.00 -$1.00 $1
1 $1 $1 $2.00 -$1.00 $1 $1.00 $2.00
2 $1 $2 $2.80 -$0.80 $1 $0.80 $1.40
3 $1 $3 $3.50 -$0.50 $1 $0.70 $1.174 $1 $4 $4.00 $0.00 $1 $0.50 $1.00
5 $1 $5 $4.50 $0.50 $1 $0.50 $0.90
6 $1 $6 $5.20 $0.80 $1 $0.70 $0.87
7 $1 $7 $6.00 $1.00 $1 $0.80 $0.86
8 $1 $8 $6.86 $1.14 $1 $0.86 $0.86
9 $1 $9 $7.86 $1.14 $1 $1.00 $0.87
10 $1 $10 $9.36 $0.64 $1 $1.50 $0.94
11 $1 $11 $12.00 -$1.00 $1 $2.64 $1.09
MR=MCMR=MC
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The Marginal Cost Curve isthe Supply Curve The marginal cost curve is the firm's
supply curve above the point whereprice exceeds average variable cost.
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The Marginal Cost Curve isthe Supply Curve The MC curve tells the competitive firm
how much it should produce at a givenprice.
The firm can do not better than produce
the quantity at which marginal cost equalsmarginal revenue which in turn equalsprice.
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The Marginal Cost Curve is
the Firms Supply Curve
A
B
CMarginal cost
C
ost,
Price
$70
60
50
40
30
20
10
0 1 Quantity2 3 4 5 6 7 8 9 10
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Firms Maximize TotalProfit Firms seek to maximize total profit, not
profit per unit. Firms do not care about profit per unit. As long as increasing output increases
total profits, a profit-maximizing firm shouldproduce more.
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Profit Maximization UsingTotal Revenue and Total Cost
Profit is maximized where the vertical
distance between total revenue andtotal cost is greatest.
At that output, MR(the slope of the
total revenue curve) andMC
(the slopeof the total cost curve) are equal.
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TC TR
0
Totalcost,
reve
nue
$385350
315280245210175140105
7035
Quantity1 2 3 4 5 6 7 8 9
Profit Determination Using Total
Cost and Revenue Curves
Maximum profit =$81
$130
Loss
Loss
Profit
Profit =$45
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., AllRights Reserved.
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Total Profit at the Profit-Maximizing Level of Output
The P = MR = MC condition tells us
how much output a competitive firmshould produce to maximize profit.
It does not tell us how much profit the
firm makes.
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Determining Profit and Loss
From a Table of Costs
Profit can be calculated from a table of
costs and revenues. Profit is determined by total revenue
minus total cost.
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Costs Relevant to a Firm
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., AllRights Reserved.
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Costs Relevant to a Firm
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., AllRights Reserved.
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Determining Profit and
Loss From a Graph Find output where MC = MR.
The intersection ofMC = MR(P)determines the quantity the firm willproduce if it wishes to maximize profits.
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Determining Profit and
Loss From a Graph Find profit per unit where MC = MR.
Drop a line down from where MC equals MR,and then to the ATC curve.
This is the profit per unit.
Extend a line back to the vertical axis toidentify total profit.
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Determining Profit and
Loss 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 curveis above the MR curve.
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) Profit case (b) Zero profit case (c) Loss case
Determining Profits Graphically
Quantity Quantity Quantity
Price65605550
454035302520
151050
65605550
454035302520
151050
1 234567891012 1 234567891012
D
MC
A P = MR
B ATC
AVCE
Profit
C
MC
ATC
AVC
MC
ATC
AVC
Loss
65605550
454035302520
151050
123456789 10
12
P = MR
P = MR
Price Price
The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
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Loss Minimization
Average cost of a unit of outputAverage cost of a unit of output
RevenueRevenue
generated by agenerated by a
unit of outputunit of output
MarketMarket
priceprice
fallsfalls
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The Shutdown Point
The firm will shut down if it cannot
cover average variable costs. A firm should continue to produce as longas price is greater than average variablecost.
If price falls below that point it makessense to shut down temporarily and savethe variable costs.
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The Shutdown Point
If total revenue is more than total
variable cost, the firms best strategy isto temporarily produce at a loss.
It is taking less of a loss than it would byshutting down.
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MC
P = MR
2 4 6 8 Quantity
Price
60
50
40
30
20
10
0
ATC
AVC
Loss
A$17.80
The Shutdown Decision
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Perfect Competition
Long Run
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Normal Profit in the Long Run Entry and exit occur whenever firms are earning
more or less than normal profit (zero
economic profit). If firms are earning more than normal profit, other firmswill have an incentive to enter the market.
If firms are earning less than normal profit, firms in the
industry will have an incentive to exit the market.
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Profit$9
10120
FirmPrice
Quantity
B
A
Market Response to an Increase in
DemandMarket
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., AllRights Reserved.
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Practice Questions
A firm faces a demand curveand cost curves . Find the
profit maximizing output (Q)at which the profit ismaximum.
10
2100
==
=
MCAC
PQ
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Practice Question
12000200
1042.0300
1 23
+=
++=
PQ
qqqTC
1. Calculate the short run supply curve from the giveninformation's
2. Find short run equilibrium output and price.