Market Structure: Perfect Competition

Chapter 7

Market Structure
Perfect Characteristic Competition
Number of firms competing Nature of the product Entry Information availability Large number Undifferentiated No barriers

Monopolistic Competition Oligopoly

Large number Differentiated Few barriers Small number Undifferentiated or differentiated Many barriers

Monopoly
Single firm Unique Blocked

Complete
None

Relatively good
Some

Asymmetric
Some

Asymmetric
Substantial

Firms control over price

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Model of Perfect Competition

A large number of firms in the market An undifferentiated product Ease of entry into the market or no barriers to entry Complete information available to all market participants

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Model of the Industry and the Firm

P S P MC ATC PE

D = P = MR

D QE Q
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Q*

Profit Maximizing Level of Output

Profit is the difference between total revenue and total cost: = TR - TC where = profit TR = total revenue TC = total cost

To maximize profits, a firm should produce the level of output where marginal revenue equals marginal cost. MR = MC where MR = TR / Q MC = TC / Q

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Marginal Revenue

The marginal revenue $ curve for the perfectly competitive firm is horizontal because the firm can sell all units of output at the market price therefore price equals marginal revenue for the perfectly competitive firm.

P = MR

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Calculation of Profit

= TR - TC = (P)(Q) - (ATC)(Q) = (P - ATC)(Q), therefore

If P > ATC, > 0 If P < ATC, < 0 If P = ATC, = 0

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Shutdown Point for a Perfectly Competitive Firm

The price, which equals a firms minimum average variable cost, below which it is more profitable for the perfectly competitive firm to shut down than to Psd continue to produce.

MC

ATC

AVC

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Supply Curve for the Perfectly Competitive Firm

The portion of a firms marginal cost curve that lies above the minimum average variable cost.

SRS =MC SRATC

SRAVC

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Long-Run Adjustment in Perfectly Competitive Industry

An increase in industry demand will result in a positive economic profit for a perfectly competitive firm. However, this profit will be competed away by the entry of other firms into the market in the long run. The zero economic profit point or the point where price equals average total cost is the equilibrium point for the perfectly competitive firm.
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Long-Run Adjustment in Perfectly Competitive Industry - Graphical

P S1 S2 PE2 PE1 MC ATC D2=P2=MR2 D1=P1=MR1 P

D1 QE1 QE2 QE3

D2 Q Q1 Q2 Q

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Long-Run Adjustment in Perfect Competition: The Optimal Scale of Production

In the long run, the perfectly competitive firm has to choose the optimal scale of operation. This decision, combined with entry and exit, will force price to equal long-run average cost.

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Long-Run Adjustment in Perfect Competition: The Optimal Scale of Production - Graphical

$

SMC1 SATC1 SMC2 SATC2 P =MR 2 2 P1=MR1 LRAC

Q1

Q2

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Examples of Competitive Industries

Agriculture Boiler Chickens Red-Meat Milk Trucking

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