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Perfectly competitive market
A perfectly competitive market features price-taking firms, a large number of identical products, free entry and exit, and complete information, maximizing profits where marginal cost equals marginal revenue. While real-world examples of perfect competition are rare, agricultural and internet-related markets demonstrate characteristics of this model. In the long run, profits attract new firms which increases supply until zero economic profits are achieved.
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Perfectly competitive market
- 2. A perfectlycompetitive market is a hypothetical market where competition is at its greatest possible level. Neo-classical economists argued that perfect competition would produce the best possible outcomes for consumers, and society. Perfect competition is sometimes referred to as "pure competition".
- 3. A perfectlycompetitive 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.
- 4. Both buyersand sellers are price takers. ◦ A price taker is a firm or individual who takes the market price as given. ◦ In most markets, households are price takers – they accept the price offered in stores.
- 5. Both buyersand sellers are price takers. – The retailer is not perfectly competitive. – A store is not a price taker but a price maker.
- 6. The numberof firms is large. – Large means that what one firm does has no bearing on what other firms do. – Any one firm's output is minuscule when compared with the total market.
- 7. There areno barriers to entry. – Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market. – Barriers sometimes take the form of patents granted to produce a certain good.
- 8. There areno barriers to entry. – Technology may prevent some firms from entering the market. – Social forces such as bankers only lending to certain people may create barriers.
- 9. The firms'products are identical. – This requirement means that each firm's output is indistinguishable from any competitor's product.
- 10. There iscomplete information. – Firms and consumers know all there is to know about the market – prices, products, and available technology. – Any technological advancement would be instantly known to all in the market.
- 11. Firms areprofit maximizers. – The goal of all firms in a perfectly competitive market is profit and only profit. – Firm owners receive only profit as compensation, not salaries.
- 12. The demandcurves facing the firm is different from the industry demand curve. A perfectly competitive firm’s demand schedule is perfectly elastic even though the demand curve for the market is downward sloping. This means that firms will increase their output in response to an increase in demand even though that will cause the price to fall thus making all firms collectively worse off.
- 13. Market supply Market demand 1,000 3,000 Price $10 8 6 4 2 0 Quantity MarketFirm Individual firm demand 10 20 30 Price $10 8 6 4 2 0 Quantity
- 14. The singlefirm takes its price from the industry, and is, consequently, referred to as a price taker. The industry is composed of all firms in the industry and the market price is where market demand is equal to market supply. Each single firm must charge this price and cannot diverge from it.
- 17. The goalof the firm is to maximize profits. When it decides what quantity to produce it continually asks how changes in quantity affect profit.
- 18. Since profitis the difference between total revenue and total cost, 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.
- 19. Total revenuefor a firm is the selling price times the quantity sold. TR = (P Q) Total revenue is proportional to the amount of output. Average revenue is total revenue divided by the quantity sold. AR = TR /Q
- 20. Marginal revenue(MR) – the change in total revenue associated with a change in quantity. MR =TR/ Q • Marginal cost (MC) -- the change in total cost associated with a change in quantity.
- 21. Since aperfect competitor accepts the market price as given, for a competitive firm, marginal revenue is price (MR = P).
- 22. Initially, marginalcost falls and then begins to rise. Marginal concepts are best defined between the numbers.
- 23. To maximizeprofits, a firm should produce where marginal cost equals marginal revenue.
- 24. If marginalrevenue 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.
- 25. The supplierwill 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.
- 26. When MR> MC, increase Q When MR < MC, decrease Q When MR = MC, Profit is maximized.
- 28. The MCcurve tells the competitive firm how much it should produce at a given price. • The firm can do no better than producing the quantity at which marginal cost equals price which in turn equals marginal revenue.
- 30. Profit ismaximized 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.
- 32. While theP = MR = MC condition tells us how much output a competitive firm should produce to maximize profit, it does not tell us the profit the firm makes.
- 33. Profit canbe calculated from a table of costs and revenues. Profit is determined by total revenue minus total cost.
- 34. Profit Maximization fora Competitive Firm P = MR Output Total Cost Marginal Cost Average Total Cost Total Revenue Profit TR-TC — 0 40.00 — — 0 –40.00 35.00 1 68.00 28.00 68.00 35.00 –33.00 35.00 2 88.00 20.00 44.00 70.00 –18.00 35.00 3 104.00 16.00 34.67 105.00 1.00 35.00 4 118.00 14.00 29.50 140.00 22.00 35.00 5 130.00 12.00 26.00 175.00 45.00 35.00 6 147.00 17.00 24.50 210.00 63.00
- 35. Profit Maximization fora Competitive Firm P = MR Output Total Cost Marginal Cost Average Total Cost Total Revenue Profit TR-TC 35.00 4 118.00 14.00 29.50 140.00 22.00 35.00 5 130.00 12.00 26.00 175.00 45.00 35.00 6 147.00 17.00 24.50 210.00 63.00 35.00 7 169.00 22.00 24.14 245.00 76.00 35.00 8 199.00 30.00 24.88 280.00 81.00 35.00 9 239.00 40.00 26.56 315.00 76.00 35.00 10 293.00 54.00 29.30 350.00 57.00
- 36. Find outputwhere MC = MR. The intersection of MC = MR (P) determines the quantity the firm will produce if it wishes to maximize profits.
- 37. Find profitper unit where MC = MR. • To determine maximum profit, you must first determine what output the firm will choose to produce. • See where MC equals MR, and then drop a line down to the ATC curve. • This is the profit per unit.
- 38. (a) Profit case(b) Zero profit case (c) Loss case Quantity Quantity Quantity Price 65 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 0 1 2 3 4 5 6 7 8 910 12 1 2 3 4 5 6 7 8 910 12 D MC A P = MR B ATC AVC 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 = MR P = MR Price Price © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
- 39. Firms canalso 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.
- 40. In allthree cases (profit, loss, zero profit), determining the profit-maximizing output level does not depend on fixed cost or average total cost, by only where marginal cost equals price.
- 41. The firmwill shut down if it cannot cover average variable costs. ◦ A firm should continue to produce as long as price is greater than average variable cost. ◦ Once price falls below that point it makes sense to shut down temporarily and save the variable costs.
- 42. As longas total revenue is more than total variable cost, temporarily producing at a loss is the firm’s best strategy since it is taking less of a loss than it would by shutting down.
- 43. While thefirm's demand curve is perfectly elastic, the industry's is downward sloping. For the industry's supply curve we use a market supply curve.
- 44. In theshort run when the number of firms in the market is fixed, the market supply curve is just the horizontal sum of all the firms' marginal cost curves, taking account of any changes in input prices that might occur.
- 45. Profits andlosses are inconsistent with long- run equilibrium. Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made. Only zero profit will stop entry.
- 46. The existenceof losses will cause firms to leave the industry. • Zero profit condition is the requirement that in the long run zero profits exist. • The zero profit condition defines the long-run equilibrium of a competitive industry.
- 47. Zero profitdoes not mean that the entrepreneur does not get anything for his efforts.
- 48. In orderto stay in business the entrepreneur must receive his opportunity cost or normal profits the owners of business would have received in the nest-best alternative.
- 49. MC P = MR 0 60 50 40 30 20 10 Price 24 6 8 Quantity SRATC LRATC
- 50. Industry supplyand demand curves come together to lead to long-run equilibrium.
- 51. An increasein demand leads to higher prices and higher profits. Existing firms increase output and new firms will enter the market, increasing output still more, price will fall until all profit is competed away.
- 52. In the realworld it is hard to find examples of industries which fit all the criteria of ‘perfect knowledge’ and ‘perfect information’. However, some industries are close. Foreign exchange markets. Here currency is all homogeneous. Also traders will have access to many different buyers and sellers. There will be good information about relative prices. When buying currency it is easy to compare prices Agricultural markets. In some cases, there are several farmers selling identical products to the market, and many buyers. At the market, it is easy to compare prices. Therefore, agricultural markets often get close to perfect competition.
- 53. Internet relatedindustries. The internet has made many markets closer to perfect competition because the internet has made it very easy to compare prices, quickly and efficiently (perfect information). Also, the internet has made barriers to entry lower. For example, selling a popular good on internet through a service like e-bay is close to perfect competition. It is easy to compare the prices of books and buy from the cheapest. The internet has enable the price of many books to fall in price, so that firms selling books on internet are only making normal profits.