Unit 2 - CH 05 - Adjusted

Understanding Economics
6th edition
by Mark Lovewell
Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.
6th edition
by Mark Lovewell
Chapter 5
Perfect Competition
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives
After this chapter you will be able to:

1. distinguish the four market structures, and
the main differences among them

2. understand the profit-maximizing rule and
how perfect competitors use it in the short
run
3. identify how perfect competitive markets
adjust in the long run, and the benefits they
provide to consumers

Market Structures
There are four main market structures:

perfect competition
monopolistic competition
oligopoly
monopoly

Perfect Competition
Perfectly competitive markets have three

main features:
many buyers and sellers
a standard product
easy entry and exit

Monopolistic
Competition
Monopolistically competitive markets have

three main features:
many buyers and sellers
slightly different products
easy entry and exit

Oligopoly and Monopoly

In an oligopoly a few businesses (protected by
entry barriers) provide standard or similar
products.
In a monopoly a single business (protected by
entry barriers) provides a product with no
close substitutes.

Entry Barriers
There are six main entry barriers in oligopolies

and monopolies:
increasing returns to scale
market experience
restricted ownership of resources
legal obstacles (such as patents)
market abuses (such as predatory pricing)
advertising (which is most common in
oligopolies)
Market Power
Market power:
is a businesss ability to affect the price it
charges
varies with market structure, such that
monopolists have the most and perfect
competitors have the least

Attributes of Market Structures

Figure 5.1, Page 119
Numbers of
Businesses
Type of
Product
Perfect
Competitio
n
Monopolisti
c
Competition
very many
many
standard
Entry and Exit of

New Business
differentiated
very easy
fairly easy
none
some
farming
restaurants
Market Power
Example

Oligopoly
Monopoly
few
one
standard or
differentiated
not
applicable
difficult
very
difficult
some
great
automobile
manufacturin
g
public
utilities
Perfect Competitors Demand (a)

A perfect competitor has a demand curve
different from the market demand curve.
The businesss demand curve is horizontal at
the prevailing market price.

Perfect Competitors Demand (b)

Figure 5.2, page 121
Pure n Simple T-Shirts

Demand Curve
Sm
Dm
0
Price ($ per T-Shirt)
Market Demand and Supply

Curves for T-Shirts
27 000
Quantity of T-Shirts per Day

0
Db
Average and Marginal

Revenue
Total revenue is used to find two other

revenue concepts:
average revenue (total revenue divided by
output)
marginal revenue (change in total revenue
divided by change in output)

Revenue Conditions for a Perfect

Competitor
Average revenue equals price, so that a
perfect competitors average revenue curve is
its horizontal demand curve.
A perfect competitors average revenue
(price) is constant so that marginal revenue
and average revenue are always equal.

Revenues for a Perfect Competitor

Revenue Schedules for Pure n Simple T-Shirts
$-6
6
6
6
6
Total Revenue Marginal Revenue

(TR)
(MR)
(P x q)
(TR/q)
Quantity
(q)
(T-Shirts per day)
$ 0
80
200
250
270
280
0
480
1200
1500
1620
1680
Average Revenue
(AR)
(TR x q)
480/80 = $6
720/120 = 6
300/50 = 6
120/20 = 6
60/10 = 6
Revenue Curves for Pure n Simple T-Shirts

$ per T-Shirt
Price
(P)
($ per T-shirt)
Db = AR = MR
0
480/80 = $6
1200/200 = 6
1500/250 = 6
1620/270 = 6
1680/280 = 6
The Profit-Maximizing
Output Rule
The profit-maximizing output rule states that

profit is maximized when marginal revenue
equals marginal cost. This means:
output should be increased if marginal revenue
exceeds marginal cost

output should be decreased if marginal cost
exceeds marginal revenue

Profit Maximization for a Perfect

Competitor
Figure 5.4, page 124Profit Maximization Table for Pure n Simple T-Shirts
Total
Product
(q)
Price
(P)
(=AR)
0
80
200
250
270
280
$6
6
6
6
6
6
Marginal
Revenue
(MR)
Marginal
Average
Cost
Variable Cost
(MC)
(AVC)
(TC/q)
(VC/q)
$
6
6
6
6
6
$1.75
1.33
2.50
5.50
10.50
Average
Cost
(AC)
(TC/q)
Total
Revenue
(TR)
$
$1.75
1.50
1.70
1.98
2.29
$12.06
5.63
5.00
5.04
5.24
0
480
1200
1500
1620
1680
Total
Cost
(TC)
$ 825
965
1125
1250
1360
1465
Total
Profit
(TR - TC)
$825
-485
75
250
260
215
Profit Maximization Graph for Pure n Simple T-Shirts

MC
6.00
a
Profit = $260
5.04
Db = MR = AR
AC
$ per T-Shirt
AVC
270

The Breakeven and Shutdown Points
The breakeven point is where a business

breaks even while maximizing profit.
For a perfect competitor this occurs where price
equals minimum average cost.
The shutdown point is the lowest price at

which a business will choose to operate in the
short run.
It occurs where price equals minimum average
variable cost.

A Perfect Competitors Supply Curve

A perfect competitors supply curve is its
marginal cost curve above the shutdown
point.
The market supply curve can be found by
horizontally adding the supply curves for all
the businesses in the industry.

Supply Curve for a Perfect Competitor

Supply Curve for Pure n Simple T-Shirts

Supply Schedule for
Pure n Simple T-Shirts
$6.00
5.00
1.50
1.40
270
250
200
0
6.00
$ per T-Shirt
Quantity
Supplied
(q)
($ per T-Shirt (T-Shirts per day)
MC(=Sb)
Price
(P)
5.00
MR1
AC
MR2
AVC
1.50
1.40
200

250 270
Supply Curves for a Perfectly Competitive

Business and Market
Business and Market Supply Schedules for T-Shirts

Price
(P)
Quantity Supplied
(q)
(Q)
(Sb)
(Sm)
(T-Shirts per day)
($ per T-Shirt)
$6.00
5.00
1.50
270
250
200
Supply Curve for T-Shirt Market

Sb
6.00
5.00
1.50
200
250270
Supply Curve for

Pure n Simply T-Shirts
27 000
25 000
20 000
Sm
6.00
5.00
1.50

20 000 25 000 27 000

Perfect Competition in the Long Run
Entry and exit by businesses in the long run

drives a perfectly competitive market to the
breakeven point.
Businesses enter markets where economic
profits are made so that supply shifts right and

price falls.
Businesses leave markets where economic
losses are made so that supply shifts left and
price rises.

Long-Run Equilibrium for a Perfectly

Competitive Business
Pure n Simply T-Shirts
T-Shirt Market
MC
S0
6
5
b
a
MR
$ per T-Shirt
$ per T-Shirt
AC
S1
d
6
5
D1
D0
0
250 270
25 000 27 000 30 000


The Benefits of Perfect Competition
Perfectly competitive markets in long-run

equilibrium meet two conditions that benefit
consumers:
minimum-cost pricing (price = minimum
average cost)
marginal-cost pricing (price = marginal cost)

How Resource Markets Operate

Marginal Productivity Theory
The demand for resources is based on the
demand for the products that these resources
are used to produce.
According to marginal productivity theory,
businesses use resources based on how much
extra profit each of these resources provides.

How Resource Markets

Operate
The Determinants of
Three factors are important in determining
Demand
the demand for a resource:
a resources marginal cost
a resources marginal product
the marginal revenue of new units of output


A Product and Resource PriceTaker
If a business is a price-taker in its product and
resource markets:
the resources marginal cost is constant
the resources marginal product is variable
the marginal revenue of new units of output is
constant


The Profit-Maximizing Employment
Rule
The profit-maximizing employment rule states

that profits are maximized when marginal
revenue product equals marginal resource
cost.
Marginal revenue product is the change in total
revenue when employing a new unit of a
resource.
Marginal resource cost is the change in total cost
when employing a new unit of a resource.


Labour Demand and Supply for a Product and Resource Price-Taker
Labour
(L)
(no. of
workers)
0
1
2
3
4
5
Labour Demand and Supply Schedules for a Strawberry Farm

Total
Product
(P)
(q)
(kilograms)
0
10
18
24
28
30
Marginal
Product
(MP)
(q/L)
(kilograms)
10
8
6
4
2
Output Price
(P)
20
16
$2
2
2
2
2
2
a
b
12
MRC = Sb
4
0
Marginal
Marginal
Revenue
Resource
Product
Cost
(MRP = TR) (MRC = W)
($ per hour)
$0
$20
$1
20
(a)
0
36
16
10
> (d)
48
(b)
10
56
12 (c)
10
60
8
10
Strawberry Farm(e)
4 (f)
Total
Revenue
(TR)
($ per kilogram) (P x q)
Labour Demand and Supply Curves for a

Wage ($ per hour)
Figure A
f
1
No. of Workers
MRP = Db
5
How Resource Markets

Operate
Market
Demand
and Supply
In a competitive
labour market:
the market demand curve is found by
horizontally summing the labour demand

curves for all businesses in the industry
the market supply curve shows the total
number of workers offering their services in this
industry at each wage


Demand and Supply in a Competitive Labour Market
Figure B
Labour Demand and Supply Curves
for Strawberry Farm Workers
Labour Demand and Supply Schedules

for Strawberry Farm Workers
$1
8
14
10
6
2
Labour
Demanded
(DM)
(no. of
(no. of
workers
workers
)
)
(farm)
(market
1
1000
)
2
2000
3
3000
4
4000
5
5000
Labour
Supplied
(SM)
(no. of
workers)
(market)
5000
4000
3000
2000
1000
SM
18
Wage ($ per hour)
Wage
(W)
($ per
hour)
14
10
6
2
DM
1000 2000 3000 4000 5000
No. of Workers

Operate
Demand for Other
Resources
Marginal productivity theory is not always
applicable to other resources.

The theory can be employed for labour and for
natural resources, because these resources are

measured in standardized units.
It is harder to calculate marginal revenue
product for capital goods, because one
investment project differs from another.

6th edition
by Mark Lovewell
Chapter 5
The End
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Unit 2 - CH 05 - Adjusted

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Understanding Economics

Copyright 2012 by McGraw-Hill Ryerson

After this chapter you will be able to:

the main differences among them

Copyright 2012 by McGraw-Hill Ryerson

There are four main market structures:

Copyright 2012 by McGraw-Hill Ryerson

Perfectly competitive markets have three

Copyright 2012 by McGraw-Hill Ryerson

Monopolistically competitive markets have

Copyright 2012 by McGraw-Hill Ryerson

Oligopoly and Monopoly

Copyright 2012 by McGraw-Hill Ryerson

There are six main entry barriers in oligopolies

Copyright 2012 by McGraw-Hill Ryerson

Attributes of Market Structures

Entry and Exit of

Copyright 2012 by McGraw-Hill Ryerson

Perfect Competitors Demand (a)

Copyright 2012 by McGraw-Hill Ryerson

Perfect Competitors Demand (b)

Pure n Simple T-Shirts

Price ($ per T-Shirt)

Price ($ per T-Shirt)

Market Demand and Supply

Quantity of T-Shirts per Day

Copyright 2012 by McGraw-Hill Ryerson

Average and Marginal

Total revenue is used to find two other

average revenue (total revenue divided by

Copyright 2012 by McGraw-Hill Ryerson

Revenue Conditions for a Perfect

Copyright 2012 by McGraw-Hill Ryerson

Revenues for a Perfect Competitor

Revenue Schedules for Pure n Simple T-Shirts

Total Revenue Marginal Revenue

Revenue Curves for Pure n Simple T-Shirts

The profit-maximizing output rule states that

exceeds marginal cost

Copyright 2012 by McGraw-Hill Ryerson

Profit Maximization for a Perfect

Profit Maximization Graph for Pure n Simple T-Shirts

Copyright 2012 by McGraw-Hill Ryerson

The Breakeven and Shutdown Points

The breakeven point is where a business

equals minimum average cost.

The shutdown point is the lowest price at

Copyright 2012 by McGraw-Hill Ryerson

A Perfect Competitors Supply Curve

Copyright 2012 by McGraw-Hill Ryerson

Supply Curve for a Perfect Competitor

Supply Curve for Pure n Simple T-Shirts

Copyright 2012 by McGraw-Hill Ryerson

Supply Curves for a Perfectly Competitive

Business and Market Supply Schedules for T-Shirts

Supply Curve for T-Shirt Market

Price ($ per T-Shirt)

Price ($ per T-Shirt)

Supply Curve for

Quantity of T-Shirts per Day

Copyright 2012 by McGraw-Hill Ryerson

20 000 25 000 27 000

Perfect Competition in the Long Run