Perfect Competition

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Perfect Competition

  1. 1. Team Member’s <ul><li>Varun Aggarwal </li></ul><ul><li>Jyoti chauhan </li></ul><ul><li>Shashank Rana </li></ul><ul><li>Preeti Pawaria </li></ul><ul><li>Rahul Yadav </li></ul><ul><li>Vijay Kundra </li></ul><ul><li>Nitin Kumar </li></ul><ul><li>Sapna Rana </li></ul>
  2. 2. Perfect Competition
  3. 3. Perfect Competition <ul><li>The concept of competition is used in two ways in economics. </li></ul><ul><ul><li>Competition as a process is a rivalry among firms. </li></ul></ul><ul><ul><li>Competition as the perfectly competitive market structure. </li></ul></ul>
  4. 4. A Perfectly Competitive Market <ul><li>A perfectly competitive market is one in which economic forces operate unimpeded. </li></ul>
  5. 5. A Perfectly Competitive Market <ul><li>A perfectly competitive market must meet the following requirements: </li></ul><ul><ul><li>Both buyers and sellers are price takers. </li></ul></ul><ul><ul><li>The number of firms is large. </li></ul></ul><ul><ul><li>There are no barriers to entry. </li></ul></ul><ul><ul><li>The firms’ products are identical. </li></ul></ul><ul><ul><li>There is complete information. </li></ul></ul><ul><ul><li>Firms are profit maximizers. </li></ul></ul>
  6. 6. The Necessary Conditions for Perfect Competition <ul><li>Both buyers and sellers are price takers. </li></ul><ul><ul><li>A price taker is a firm or individual who takes the market price as given. </li></ul></ul><ul><ul><li>In most markets, households are price takers – they accept the price offered in stores. </li></ul></ul>
  7. 7. The Necessary Conditions for Perfect Competition <ul><li>Both buyers and sellers are price takers. </li></ul><ul><ul><li>The retailer is not perfectly competitive. </li></ul></ul><ul><ul><li>A retail store is not a price taker but a price maker. </li></ul></ul>
  8. 8. The Necessary Conditions for Perfect Competition <ul><li>The number of firms is large. </li></ul><ul><ul><li>Large means that what one firm does has no bearing on what other firms do. </li></ul></ul><ul><ul><li>Any one firm's output is minuscule when compared with the total market. </li></ul></ul>
  9. 9. The Necessary Conditions for Perfect Competition <ul><li>There are no barriers to entry. </li></ul><ul><ul><li>Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market. </li></ul></ul><ul><ul><li>Barriers sometimes take the form of patents granted to produce a certain good. </li></ul></ul>
  10. 10. The Necessary Conditions for Perfect Competition <ul><li>There are no barriers to entry. </li></ul><ul><ul><li>Technology may prevent some firms from entering the market. </li></ul></ul><ul><ul><li>Social forces such as bankers only lending to certain people may create barriers. </li></ul></ul>
  11. 11. The Necessary Conditions for Perfect Competition <ul><li>The firms' products are identical. </li></ul><ul><ul><li>This requirement means that each firm's output is indistinguishable from any competitor's product. </li></ul></ul>
  12. 12. The Necessary Conditions for Perfect Competition <ul><li>There is complete information. </li></ul><ul><ul><li>Firms and consumers know all there is to know about the market – prices, products, and available technology. </li></ul></ul><ul><ul><li>Any technological breakthrough would be instantly known to all in the market. </li></ul></ul>
  13. 13. The Necessary Conditions for Perfect Competition <ul><li>Firms are profit maximizers. </li></ul><ul><ul><li>The goal of all firms in a perfectly competitive market is profit and only profit. </li></ul></ul><ul><ul><li>The only compensation firm owners receive is profit, not salaries. </li></ul></ul>
  14. 14. The Definition of Supply and Perfect Competition <ul><li>If all the necessary conditions for perfect competition exist, we can talk formally about the supply of a produced good. </li></ul>
  15. 15. The Definition of Supply and Perfect Competition <ul><li>Supply is a schedule of quantities of goods that will be offered to the market at various prices. </li></ul>
  16. 16. The Definition of Supply and Perfect Competition <ul><li>When a firm operates in a perfectly competitive market, it’s supply curve is that portion of its short-run marginal cost curve above average variable cost. </li></ul>
  17. 17. Demand Curves for the Firm and the Industry <ul><li>The demand curves facing the firm is different from the industry demand curve. </li></ul><ul><li>A perfectly competitive firm’s demand schedule is perfectly elastic even though the demand curve for the market is downward sloping. </li></ul>
  18. 18. Demand Curves for the Firm and the Industry <ul><li>Individual 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. </li></ul>
  19. 19. Market Demand Versus Individual Firm Demand Curve Market Firm Individual firm demand Market supply Market demand 1,000 3,000 Price $10 8 6 4 2 0 Quantity 10 20 30 Price $10 8 6 4 2 0 Quantity
  20. 20. Profit-Maximizing Level of Output <ul><li>The goal of the firm is to maximize profits. </li></ul><ul><li>Profit is the difference between total revenue and total cost. </li></ul>
  21. 21. Profit-Maximizing Level of Output <ul><li>What happens to profit in response to a change in output is determined by marginal revenue ( MR ) and marginal cost ( MC ). </li></ul><ul><li>A firm maximizes profit when MC = MR . </li></ul>
  22. 22. Profit-Maximizing Level of Output <ul><li>Marginal revenue ( MR ) – the change in total revenue associated with a change in quantity. </li></ul><ul><li>Marginal cost ( MC ) – the change in total cost associated with a change in quantity. </li></ul>
  23. 23. Marginal Revenue <ul><li>A perfect competitor accepts the market price as given. </li></ul><ul><li>As a result, marginal revenue equals price ( MR = P ). </li></ul>
  24. 24. Marginal Cost <ul><li>Initially, marginal cost falls and then begins to rise. </li></ul><ul><li>Marginal concepts are best defined between the numbers. </li></ul>
  25. 25. Profit Maximization: MC = MR <ul><li>To maximize profits, a firm should produce where marginal cost equals marginal revenue. </li></ul>
  26. 26. How to Maximize Profit <ul><li>If marginal revenue does not equal marginal cost, a firm can increase profit by changing output. </li></ul><ul><li>The supplier will continue to produce as long as marginal cost is less than marginal revenue. </li></ul>
  27. 27. How to Maximize Profit <ul><li>The supplier will cut back on production if marginal cost is greater than marginal revenue. </li></ul><ul><li>Thus, the profit-maximizing condition of a competitive firm is MC = MR = P . </li></ul>
  28. 28. Marginal Cost, Marginal Revenue, and Price McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. C A P = D = MR Costs 1 2 3 4 5 6 7 8 9 10 Quantity 60 50 40 30 20 10 0 A B MC 0 1 2 3 4 5 6 7 8 9 10 $28.00 20.00 16.00 14.00 12.00 17.00 22.00 30.00 40.00 54.00 68.00 Price = MR Quantity Produced Marginal Cost $35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00
  29. 29. The Marginal Cost Curve Is the Supply Curve <ul><li>The marginal cost curve is the firm's supply curve above the point where price exceeds average variable cost. </li></ul>
  30. 30. The Marginal Cost Curve Is the Supply Curve <ul><li>The MC curve tells the competitive firm how much it should produce at a given price. </li></ul><ul><li>The firm can do no better than produce the quantity at which marginal cost equals marginal revenue which in turn equals price. </li></ul>
  31. 31. The Marginal Cost Curve Is the Firm’s Supply Curve A B C Marginal cost Cost, Price $70 60 50 40 30 20 10 0 1 Quantity 2 3 4 5 6 7 8 9 10
  32. 32. Firms Maximize Total Profit <ul><li>Firms seek to maximize total profit, not profit per unit. </li></ul><ul><ul><li>Firms do not care about profit per unit. </li></ul></ul><ul><ul><li>As long as increasing output increases total profits, a profit-maximizing firm should produce more. </li></ul></ul>
  33. 33. Profit Maximization Using Total Revenue and Total Cost <ul><li>Profit is maximized where the vertical distance between total revenue and total cost is greatest. </li></ul><ul><li>At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal. </li></ul>
  34. 34. Profit Determination Using Total Cost and Revenue Curves Profit =$45 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. TC TR 0 Total cost, revenue $385 350 315 280 245 210 175 140 105 70 35 Quantity 1 2 3 4 5 6 7 8 9 Maximum profit =$81 $130 Loss Loss Profit
  35. 35. Total Profit at the Profit-Maximizing Level of Output <ul><li>The P = MR = MC condition tells us how much output a competitive firm should produce to maximize profit. </li></ul><ul><li>It does not tell us how much profit the firm makes. </li></ul>
  36. 36. Determining Profit and Loss From a Table of Costs <ul><li>Profit can be calculated from a table of costs and revenues. </li></ul><ul><li>Profit is determined by total revenue minus total cost. </li></ul>
  37. 37. Costs Relevant to a Firm McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
  38. 38. Costs Relevant to a Firm McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
  39. 39. Determining Profit and Loss From a Graph <ul><li>Find output where MC = MR . </li></ul><ul><ul><li>The intersection of MC = MR ( P ) determines the quantity the firm will produce if it wishes to maximize profits. </li></ul></ul>
  40. 40. Determining Profit and Loss From a Graph <ul><li>Find profit per unit where MC = MR. </li></ul><ul><ul><li>Drop a line down from where MC equals MR, and then to the ATC curve. </li></ul></ul><ul><ul><li>This is the profit per unit. </li></ul></ul><ul><ul><li>Extend a line back to the vertical axis to identify total profit. </li></ul></ul>
  41. 41. Determining Profit and Loss From a Graph <ul><li>The firm makes a profit when the ATC curve is below the MR curve. </li></ul><ul><li>The firm incurs a loss when the ATC curve is above the MR curve. </li></ul>
  42. 42. Determining Profit and Loss From a Graph <ul><li>Zero profit or loss where MC=MR. </li></ul><ul><ul><li>Firms can earn zero profit or even a loss where MC = MR. </li></ul></ul><ul><ul><li>Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs. </li></ul></ul>
  43. 43. Determining Profits Graphically (a) Profit case (b) Zero profit case (c) Loss case © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill 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 9 10 12 1 2 3 4 5 6 7 8 9 10 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 9 10 12 P = MR P = MR Price Price
  44. 44. The Shutdown Point <ul><li>The firm will shut down if it cannot cover average variable costs. </li></ul><ul><ul><li>A firm should continue to produce as long as price is greater than average variable cost. </li></ul></ul><ul><ul><li>If price falls below that point it makes sense to shut down temporarily and save the variable costs. </li></ul></ul>
  45. 45. The Shutdown Point <ul><li>The shutdown point is the point at which the firm will be better off it shuts down than it will if it stays in business. </li></ul>
  46. 46. The Shutdown Point <ul><li>If total revenue is more than total variable cost, the firm’s best strategy is to temporarily produce at a loss. </li></ul><ul><li>It is taking less of a loss than it would by shutting down. </li></ul>
  47. 47. The Shutdown Decision MC P = MR 2 4 6 8 Quantity Price 60 50 40 30 20 10 0 ATC AVC Loss A $17.80
  48. 48. Short-Run Market Supply and Demand <ul><li>While the firm's demand curve is perfectly elastic, the industry's is downward sloping. </li></ul><ul><li>For the industry's supply curve we use a market supply curve. </li></ul>
  49. 49. Short-Run Market Supply and Demand <ul><li>The market supply curve is the horizontal sum of all the firms' marginal cost curves, taking account of any changes in input prices that might occur. </li></ul>
  50. 50. Long-Run Competitive Equilibrium <ul><li>Profits and losses are inconsistent with long-run equilibrium. </li></ul><ul><ul><li>Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made. </li></ul></ul><ul><ul><li>The existence of losses will cause firms to leave the industry. </li></ul></ul>
  51. 51. Long-Run Competitive Equilibrium <ul><li>Only at zero profit will entry and exit stop. </li></ul><ul><li>The zero profit condition defines the long-run equilibrium of a competitive industry. </li></ul>
  52. 52. Long-Run Competitive Equilibrium 0 MC P = MR 60 50 40 30 20 10 Price 2 4 6 8 Quantity SRATC LRATC
  53. 53. Long-Run Competitive Equilibrium <ul><li>Zero profit does not mean that the entrepreneur does not get anything for his efforts. </li></ul><ul><li>Normal profit – the amount the owners of business would have received in the next-best alternative. </li></ul>
  54. 54. Long-Run Competitive Equilibrium <ul><li>Normal profits are included as a cost and are not included in economic profit. </li></ul><ul><li>Economic profits are profits above normal profits. </li></ul>
  55. 55. Long-Run Competitive Equilibrium <ul><li>Firms with super-efficient workers or machines will find that the price of these specialized inputs will rise. </li></ul><ul><li>Rent is the income received by those specialized factors of production. </li></ul>
  56. 56. Long-Run Competitive Equilibrium <ul><li>The zero profit condition makes the analysis of competitive markets applicable to the real world. </li></ul><ul><li>To determine whether markets are competitive, many economist focus on whether barriers to entry exist. </li></ul>
  57. 57. Adjustment from the Long Run to the Short Run <ul><li>Industry supply and demand curves come together to lead to long-run equilibrium. </li></ul>
  58. 58. An Increase in Demand <ul><li>An increase in demand leads to higher prices and higher profits. </li></ul><ul><ul><li>Existing firms increase output. </li></ul></ul><ul><ul><li>New firms enter the market, increasing output still more. </li></ul></ul><ul><ul><li>Price falls until all profit is competed away. </li></ul></ul>
  59. 59. An Increase in Demand <ul><li>If input prices remain constant, the new equilibrium will be at the original price but with a higher output. </li></ul>
  60. 60. An Increase in Demand <ul><li>The original firms return to their original output but since there are more firms in the market, the total market output increases. </li></ul>
  61. 61. An Increase in Demand <ul><li>In the short run, the price does more of the adjusting. </li></ul><ul><li>In the long run, more of the adjustment is done by quantity. </li></ul>
  62. 62. Market Response to an Increase in Demand Profit B A B A C McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. $9 10 12 0 Firm Price Quantity Market Quantity Price 0 MC AC S LR S 0 SR D 0 7 700 $9 840 1,200 D 1 S 1 SR 7
  63. 63. Long-Run Market Supply <ul><li>In the long run firms earn zero profits. </li></ul><ul><li>If the long-run industry supply curve is perfectly elastic, the market is a constant-cost industry . </li></ul>
  64. 64. Long-Run Market Supply <ul><li>Two other possibilities exist: </li></ul><ul><ul><li>Increasing-cost industry – factor prices rise as new firms enter the market and existing firms expand capacity. </li></ul></ul><ul><ul><li>Decreasing-cost industry – factor prices fall as industry output expands. </li></ul></ul>
  65. 65. An Increasing-Cost Industry <ul><li>If inputs are specialized, factor prices are likely to rise when the increase in the industry-wide demand for inputs to production increases. </li></ul>
  66. 66. An Increasing-Cost Industry <ul><li>This rise in factor costs would force costs up for each firm in the industry and increases the price at which firms earn zero profit. </li></ul>
  67. 67. An Increasing-Cost Industry <ul><li>Therefore, in increasing-cost industries, the long-run supply curve is upward sloping. </li></ul>
  68. 68. A Decreasing-Cost Industry <ul><li>If input prices decline when industry output expands, individual firms' marginal cost curves shift down and the long-run supply curve is downward sloping. </li></ul>
  69. 69. A Decreasing-Cost Industry <ul><li>Input prices may decline to the zero-profit condition when output rises. </li></ul><ul><li>New entrants make it more cost-effective for other firms to provide services to all firms in the market. </li></ul>
  70. 70. An Example in the Real World <ul><li>K-mart decided to close over 300 stores after experiencing two years of losses (a shutdown decision). </li></ul><ul><li>K-mart thought its losses would be temporary. </li></ul>
  71. 71. An Example in the Real World <ul><li>Price exceeded average variable cost, so it continued to keep some stores open even though those stores were losing money. </li></ul>
  72. 72. An Example in the Real World Price Quantity MC ATC AVC P = MR Loss
  73. 73. An Example in the Real World <ul><li>After two years of losses, its prospective changed. </li></ul><ul><li>The company moved from the short run to the long run. </li></ul>
  74. 74. An Example in the Real World <ul><li>They began to think that demand was not temporarily low, but permanently low. </li></ul><ul><li>At that point they shut down those stores for which P < AVC . </li></ul>
  75. 75. Thank you!

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