Perfect Competition

IMPORTANCE OF MARKET STRUCTURE The type of decisions a firm takes and the potential of the firm to earn profits in the long run , depends on the type of market structure in which the firm operates.

Market structure
Perfect competition Imperfect competition

monopoly

Monopolistic competition

oligopoly

Characteristics of a perfectly competitive market

Large no of buyers and sellers Homogenous product Free entry and exist of firms Perfect mobility Absence of transportation cost

Demand curve of a firm in competitive market

price P=AR=MR

quantity

The equilibrium price

Eq.p rice

quantity

CASE study
Credit cards and perfect competition

Profit maximization in the short run

Qd=170,000,000-10,000,000P Qs=70,000,000+15,000,000P Equilibrium price is at Qd=Qs 170,000,000-10,000,000P=70,000,000+ 15,000,000P Or170,000,000-70,000,000=15,000,000P+10,000,000P OR 100,000,000=25,000,000P Or P=4

ENTRY AND EXIST

Afirm with function 1000+1000P leaves Qs will become 69,999,000+14,999,000P Equilibrium price will be 4.0002 a very little effect

nUMERICALS
Anew pizza place , fredricos opens in new york city .The average price of a medium pizza in newyork is $10The owner esimated tha total costs including a normal profit will be TC=1000+2Q+0.01Q2 TO maximize the
profit how many pizzas should be made

Solutions
MC=dTC/Dq=2+0.02Q PROFIT IS MAXIMIZED AT P=MC 10=0.02Q+2 OR Q =400 ECONOMIC PROFIT=tr-tc 10*400(1000+2*400+0.01*4002)=$600

Structure of the cost curves

MC

p E

D=ar=Mr
Profit A C QE

qM

Total cost and total revenues

Market price
10 10 10

Rate of output and sales

1 2 3

Total revenue
10 20 30

Total fixed cost

30 30 30

Total variable cost

4 7 9

Total cost

profit

34 37 39

-24 -17 -9

10
10 10 10 10 10

4
5 6 7 8 9

40
50 60 70 80 90

30
30 30 30 30 30

11.5
14.5 18.5 25 35 51

41.5
44.5 48.5 55 65 81

-1.5
5.5 11.5 15 15 9

10

10

100

30

75

105

-5

Market structure
PRICE TR TC

E QUANTITY

Calculating the shut down price Abicycle manufacturer faces ahorizontal demand curve .the firms total costs are given by the equation TVC=150Q-20Q2+Q3 AT WHAT
PRICE THE FIRM SHOULD SHUT DOWN

SOLUTIONS
MC=dTVC/dQ =150-40Q+3Q2 AVC=TVC/Q=150-20Q+Q2 150-20Q+Q2=150-40Q +3Q2 =2Q2-20Q=0OR Q=10 P=MC=MR=AR=50 THUS IF THE PRICE FALLS BELOW $50PER UNIT THE FIRM SHOULD SHUT DOWN

When should a firm close down

As long as price exceeds average variable costs, the firm is better off if it continues to produce. The reason is that revenue will be sufficient to cover variable costs and make a contribution to the payment of the firms fixed costs. In contrast shutting down means that the firms loss is entire fixed cost.

price MC

ATC

A VC
P Ps quantity Shut down point

Profit maximizing output in the long run

Shut down
The rule does not necessarily mean that managers should shut down operations every time price drops below average variable cost. A decision to shut down will be made only if it is expected that price will remain below average variable cost for an extended period of time.

Key concepts to remember

In the long run, economic profit is eliminated by the entry of new firms. THE profit maximizing rate of output occurs where price equals both marginal and average cost. Consumers who would have been willing to pay more than the market price receive a consumer surplus when they buy the product . In perfectly competitive markets(1)the value of the last unit exchanged equals the opportunity cost of producing it.(2)capital moves to its highest valued use.(3)production takes place at the minimum point on the average cost curve.

Consumer surplus
s cs

Pe

Characteristics of Perfect competition

Marginal costs are a measure of the opportunity cost of producing one more unit of the product.For ex to produce an additional automobile fuel , labour, capital must be diverted from other uses. The value of these inputs in those other uses is measured by their cost. The sum of these input costs is the marginal cost and represents the opportunity cost of producing an additional car, as shown by the supply curve.

characteristics
The profit maximizing firm in perfect competition will expand production until price equals marginal cost.Concurrently,buyers will purchase the firms product until price exceeds the relative value that they attach to the product.Because of the price paid by the consumer is identical to the additional revenue received .

characteristics
Perfect competition results in the right amount of product being produced. Resources are efficiently allocated among alternative uses