the model of the perfect competition

1. THE MODEL OF PERFECT COMPETITION
Dr Arifa Saeed

2. PERFECT COMPETITION - AN IDEAL
 Firms are primarily distinguished from each other by
the degree of competition they face:
Profit maximization.
The Model of Perfect Competition.
Allocative and Productive efficiencies.
Long-run costs and adjustments
Perfect
Competition Monopoly
Monopolistic
Competition
Oligopoly

3. PROFIT MAXIMIZING RULE
 No matter what kind of firm we are
talking about, they will max. profit when:
Marginal Revenue = Marginal Cost
(MR) (MC)
 If MR > MC, you are foregoing profit.
 If MR < MC, you are foregoing profit.

4. PERFECT COMPETITION
 All goods are identical.
--One cannot be (usefully) distinguished from another.
 Many buyers and sellers.
--No one can affect price through their actions.
 There are no barriers to entry/exit.
--Firms cannot earn economic profit in the long run.
 Buyers & sellers have perfect information.
--A single price will prevail in the market.

5. PERFECT COMPETITION
 Market price = price to the firm = MR
(This is the “demand” for the firm’s output & is perfectly elastic.)
MC
q*
Q
Qe
Pe
P
S
D
$
Pe = MR = d
q
A Firm
The Market
q1 q2

6. PERFECT COMPETITION
How can we tell if a firm
makes a profit?
Calculate:
Total Revenue = P•q*
& Total Cost = ATC •q*
Econ Profit = TR - TC
$
MR = d
q
A Firm
Pe
MC
q*
ATC

7. SCENARIO #1 - POSITIVE PROFIT
The ATC must be less than the price,
so that calculated profit is positive.
$
MR = d
q
A Firm
Pe
MC
q*
ATC
What will
happen in this
industry in the
long run?

8. SCENARIO #2 - ZERO ECON
PROFIT
The ATC must be equal to the price, so
that calculated profit is zero.
A Firm
$
MR = d
q
Pe
MC
q*
ATC
What will
happen in this
industry in the
long run?

9. SCENARIO #3 - NEGATIVE
PROFIT I
The ATC must be more than the price,
so that calculated profit is negative.
What will
happen in this
industry in the
long run?
$
MR = d
q
A Firm
Pe
MC
q*
ATC
AVC
Will this firm stay
in business in the
short run?
It depends . . .

10. SCENARIO #3 - NEGATIVE PROFIT
II:
THE SHUTDOWN POINT
The firm will shut down, right away, if the
Price (MR) is less than the AVC…
or, if the total loss > fixed costs
What will
happen in this
industry in the
long run?
$
MR = d
q
A Firm
Pe
MC
q*
ATC
AVC
Fixed Costs
Do worksheet
on perfect
competition.

11. PERFECT COMPETITION & EFFICIENCY
Allocative Efficiency (What to produce?)
Productive Efficiency (How to produce?)
occurs when Price = Marginal Cost
Why ?
occurs where output level is at the
minimum ATC
Why ?

12. PERFECT COMPETITION & EFFICIENCY
Perfectly competitive firms are always Allocatively Efficient
Perfectly competitive
firms always charge a
price = MC. Why?
$
MR = d
q
Pe
MC
q*
ATC
In the LR, perfectly
competitive firms produce
at min. ATC. Why?
In the LR, perfectly competitive firms are Productively Efficient

13. PERFECT COMPETITION IN LR
We know that in SR, firms can earn a positive,
or negative, economic profit.
What happens in the long run?
Q
Qe
Pe
P
S
D
The Market
Q
Qe
Pe
P
S
D
The Market
If econ profits
are positive,
entry occurs
S*
If econ profits
are negative,
exit occurs
S*

14. PERFECT COMPETITION IN LR
If a firm earns positive economic profit, in the
long run that will be dissipated as firms enter.
Q
Qe
Pe
P
S
D
The Market
$
MR = d
q
A Firm
Pe
MC
q*
ATC
S*
MR* = d*
Pe*
q*
In the LR,
this firm
earns 0
econ profit.

15. PERFECT COMPETITION IN LR
If a firm earns negative economic profit, in the
long run that will be eliminated as firms exit.
Q
Qe
Pe
P
S
D
The Market
$
MR = d
q
A Firm
Pe
MC
q
ATC
In the LR,
this firm
earns 0
econ profit.
q*
MR* = d*
Pe*
S*

16. THE PARADOX OF TAXING ECONOMIC
PROFIT
In the short run, there are no consequences!
MC
q
Q
Qe
Pe
P
S
D*
$
Pe = MR = d
q
A Firm
The Market
D
ATC
q*
P* MR* = d*