Reading 18 - Perfect Competition

Friday, August 29, 2008

3:17 PM
Perfectly Competitive Market
o Many firms selling identical products
o Each firm produces only small portion of total supply
o Firms are price takers since they have no leverage to influence the market
price via any actions
o Perfectly elastic demand curve(horizontal straight line) and = Market Price
• But market elasticity is > 0 and less than infinity
o Firm's revenue is linear

Maximizing Profits in PC
o Produce up to the point where MC = MR = Price

o When MR > MC increase in output increases economic profit

o When MR < MC increase in output causes an economic loss. When Price = MR
< MC, firm temporarily shuts down. But when firm is covering its fixed costs,
continue operating
o an increase in industry demand will increase equilibrium price and output. At the
higher price, firms will earn positive economic profits in the short run because the
higher price will exceed average total cost

Short Run Supply Curve

o Portion of MC curve that lies at or above the minimum value of the AVC
and always slopes upward
o In the long run, firms will adjust their plant sizes until it maximizes profits
which is the size with the lowest SRAC curve. All firms in PC will operate with
the most efficient(lowest cost) plant size
o Over the LR, the supply curve is typically more elastic(flatter) than in the SR.
This is because they have more capacity to adjust their production scale and
methods over the LR vs the SR.

In PC in the LR, economic profits in the industry will be zero.

• Entry and plant expansion increase supply and lower price and profit
• Exit and downsizing decrease supply and raise price and profit.
• Industry as a whole outputs less but remaining firms output more
• This means the firms are just profitable enough to compensate them for the
risks taken on their capital. NPV = 0

Increasing Cost Industries - experience external diseconomies of scale. LR supply

curve slopes upwards and LRAC curves will shift upwards

Decreasing Cost Industries - experience external economies of scale(benefits of

technology and specialization). LR supply curves slope downward and LRAC curves
shift downwards

Constant Cost Industries - LR supply curve is flat.

More elastic = less steep

In the SR, the economic profit of a firm can be +, - or 0 but in LR it will always be
zero.

Quizzing Notes
• Watch for questions that try to make a supplier seem like a monopoly when it's
really facing PC which means it's a price taker.
• To find max production level, calculate where MC = MR. Also remember that
supply curve will - MC curve portion above AVC.