dynamics of markets

2. In This Lecture…
Concept of Perfect
Competition Market
Features of Perfectly
Competition Market
Conditions of Short-
Run and Long-Run
Competitive
Equilibrium

3. Market Structure
The particular environment of a firm, the
characteristics of which influence the
firm’s pricing and output decisions.

4. The Theory of Perfect Competition
A theory of market structure based on four
assumptions:
(1)There are many buyers and sellers
(2)Each firm produces and sells a homogeneous
product.
(3)Buyers and sellers have perfect knowledge
about the market i.e. all relevant information
with respect to prices, product quality, sources
of supply, and so on.
(4)There is free or easy entry and exit from the
industry.

5. A Perfectly Competitive Firm is a
Price Taker
A seller in perfect competition market does
not have the ability to control the price of
the product it sells; it takes the price
determined in the market by the market
demand and market supply forces.
In Perfect Competition market
P=AR=MR=d

6. Market Demand Curve and Firm
Demand Curve in Perfect Competition
 The market, composed of all buyers and sellers,
establishes the equilibrium price. (a)
 A single perfectly competitive firm then faces a
horizontal (flat, perfectly elastic) demand curve. (b)

7. Quantity of Output the Perfectly
Competitive Firm Will Produce
The firm’s demand
curve is horizontal
at the equilibrium
price. Its demand
curve is its marginal
revenue curve. The
firm produces that
quantity of output
at which MR = MC.

8. Profit-Maximization Rule
Profit is maximized by producing the
quantity of output at which MR = MC.
For Perfect Competition, profit is
maximized when P = MR = MC*
* This condition is unique for perfect competition and does not hold for other market
structures.

9. Resource Allocative Efficiency
 Producing a good—any good—until price
equals marginal cost ensures that all units of the
good are produced that are of greater value to
buyers than the alternative goods that might
have been produced.
 A firm that produces the quantity of output at
which price equals marginal cost (P = MC) is
said to exhibit resource allocative efficiency.
 For a perfectly competitive firm, profit
maximization and resource allocative efficiency
are not at odds.

10. Profit Maximization
and Loss Minimization
for the Perfectly
Competitive Firm:
Three Cases I
 In Case 1, TR TC and
the firm earns profits.
 It continues to produce
in the short run.

11.  In Case 2, TR < TC and
the firm takes a loss.
 It shuts down in the
short run because it
minimizes its losses by
doing so; it is better to
lose $400 in fixed costs
than to take a loss of
$450.
Profit Maximization
and Loss Minimization
for the Perfectly
Competitive Firm:
Three Cases II

12.  In Case 3, TR < TC and
the firm takes a loss.
 It continues to produce
in the short run because
it minimizes its losses
by doing so; it is better
to lose $80 by producing
than to lose $400 in
fixed costs by not
producing.
Profit Maximization
and Loss Minimization
for the Perfectly
Competitive Firm:
Three Cases III

13. What Should a Perfectly Competitive
Firm Do in the Short Run?
 The firm should produce in the short run as long
as price (P) is above average variable cost
(AVC).
 It should shut down in the short run if price is
below average variable cost.

14. The Perfectly Competitive Firm’s
Short-Run Supply Curve
The short-run
supply curve is that
portion of the firm’s
marginal cost curve
that lies above the
average variable
cost curve.

15. Long-Run Equilibrium
Long-run competitive equilibrium
exists when:
there is no incentive for firms to
enter or exit the industry,
there is no incentive for firms to
produce more or less output, and
there is no incentive for firms to
change plant size.

16. Productive Efficiency
The situation that exists when a firm
produces its output at the lowest possible
per-unit cost (lowest ATC).
The perfectly competitive firm does this in
the long-run.

17. Long-Run Competitive
Equilibrium
The condition where:
P = MC = SRATC = LRATC.
There are zero economic profits, firms are
producing the quantity of output at which
price is equal to marginal cost, and no
firm has an incentive to change its plant
size.

18. Long-Run Competitive Equilibrium in the
Market and the Firm
P = MC (the firm has no incentive to move away from the quantity of
output at which this occurs, q1);
P = SRATC (there is no incentive for firms to enter or exit the industry);
and
SRATC= LRATC (there is no incentive for the firm to change its plant
size).

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