erfecL CompeLlLlon

JfL ls f MfrkeL?
lL refers Lo Le lnsLlLuLlonf refLlonslp beLween
buyers fnd seers of f good or servlce fL f
muLufy fgreed upon prlce
ln order Lo fnfyse fnd undersLfnd Le economlc
dlmenslons of declslon mfklng ln respecL of
producLlon cosL prlclng eLc Le ffcLors fffecLlng
Le mfrkeL merlL dlscusslon 1ese fre fs foows
1ype of mfrkeL
nfLure of compeLlLlon
nfLure of Le producL
number fnd slze of buyers fnd seers
nfLure of enLry lnLo fnd exlL from Le mfrkeL
1ype of mfrkeLs
erfecL compeLlLlon
Monopoy
MonopolsLlc CompeLlLlon
Clgopoy
erfecL CompeLlLlon
CfrfcLerlsLlcs of perfecL compeLlLlon
(|) Large number of buyers and se||ers
1e number of seers or supplers ln Le mfrkeL
fre Loo frge Lo lnfuence Le prlce of Le mfrkeL
Aso Le number of buyers fre very frge ln
number fnd Ley cfn noL exerL fny lnfuence on
Le mfrkeL prlce
(||) nomogeneous product
1e producLs of perfecLy compeLlLlve mfrkeLs fre
so ldenLlcf LfL Le buyers fre noL fbe Lo
dlsLlnguls Le producL of one flrm from fnoLer
flrm Lxfmpe sfy unbrfnded splces
lL ls dlfflcuL Lo dlsLlnguls beLween splces sod fcross
Le mfrkeL 1e buyers fre LoLfy lndlfferenL Lowfrds
vfrlous seers wlL respecL Lo purcfse of Le producL
becfuse Le producLs of f Le flrms fre perfecL
subsLlLuLes Lo efc oLer
(lll)reedom of entry and ex|t
1ere ls no bfrrler Lo Le enLry fnd exlL of new flrms
lnLo Le lndusLry under perfecLy compeLlLlve mfrkeL
(lv) erfect know|edge
1e buyers fnd seers fve compeLe lnformfLlon fnd
knowedge fbouL Le mfrkeL ln respecL of prlces of
lnpuLs Lecnoogy used mfrkeL prlce of Le producL
quflLy of Le producL eLc
(v) erfect|y e|ast|c demand curve
1e demfnd under perfecL compeLlLlon ls lnflnlLey
efsLlc becfuse Le buyers fve perfecL knowedge
fbouL Le producL fnd Le prevfllng mfrkeL prlce
(vl) erfect mob|||ty of the factors of product|on
8esources fre free Lo move from one flrm Lo
fnoLer fnd cfn respond prompLy Lo fny cfnge
ln ffcLor pfymenLs
erfect compet|t|on and pure compet|t|on 1e
dlfference ls f mfLLer of degree 1e fefLures of
perfecL mobllLy fnd perfecL knowedge fre fbsenL
ln pure compeLlLlon
erfecL compeLlLlon ls noL very common ln Le
buslness word Powever Le mfrkeLs of
perfecL compeLlLlon LfL fpproxlmfLes Lo Le
condlLlons of perfecLy compeLlLlve mode
lncude sfre mfrkeLs credlL cfrd mfrkeLs
fgrlcuLurf producL mfrkeL eg ocf vegeLfbe
mfrkeLs eLc uesplLe lLs uncommonness Le
mode ls mosL popufr ln economlcs due Lo lLs
fnfyLlcf vfue lL provldes Le fundfmenLf
concepLs for prlclng Leory
8evenue CosL fnd proflL of Le flrm
181oLf revenue lL ls Le muLlplcfLlon of prlce of Le
producL fnd Le qufnLlLy sod
C
M8 Mfrglnf revenue
lL ls Le fddlLlonf revenue LfL f flrm mfkes by selng
one exLrf unlL of ouLpuL
Averfge revenue A8rlce()
CosL of Le flrm 1C MC fnd AC
1o mfxlmlse proflL
Mfx 8(C) C (C)
1e flrsL order condlLlon of proflL mfxlmlsfLlon
d /dCd8(C)/dC dC(C)/dC0
M8MC0
M8MC
1e second order condlLlon of proflL
mfxlmlsfLlon ls d
2
/dC
2
0
or dM8/dC dMC/dC 0
Sope of M8 curve sope of MC curve
1o sum up Le proflL mfxlmlslng condlLlons
{i) Necessory condition MkMc
{ii) 5ufficient condition Mc curve cuts the Mk
curve from be/ow
er|ods cons|dered for pr|ce and out put
determ|nat|on mfrkeL or very sorL perlod
sorL perlod/run fnd ong perlod or ong run
1e mfrkeL prlce under C ls deLermlned
by Le mfrkeL demfnd fnd mfrkeL suppy
wlc ln Lurn fre deLermlned by Le
lndusLry 1erefore Le seer under C ls
f rice toker noL f rice moker
neoce ooJet lc tbe ptoflt moxlmlsloq fltm
coooot Jetetmloe tbe ptlce of lts ptoJoct
bot to oJjost lts ootpot to tbe motket ptlce
lo otJet to moxlmlse lts ptoflt
lndusLry (mfrkeL
demfnd)
llrm (mfrkeL
demfnd)
u
S
CufnLlLy

r
l
c
e
CufnLlLy
r|ce
M8A8
1e demfnd curve for Le lndusLry ls f sLfndfrd downwfrd soplng
curve fnd Le demfnd curve for Le flrm ls f orlzonLf sLrflgL lne
L
C*
*
LxpfnfLlon
emand curve
1e demfnd curve for Le lndusLry sows
fLernfLlve comblnfLlons of prlce fnd ouLpuL
fvflfbe Lo Le buyers suc LfL fn lndlvlduf
buyer ls fbe Lo geL Le mfxlmum fmounL of
ouLpuL fL efc exlsLlng prlce fL f glven Llme
1e buyer woud demfnd more fL ower prlces
fnd ess fL lger prlces
1e lndlvlduf demfnd curve sows LfL Le
flrm cfn se lnflnlLe voume of ouLpuL fL Le
sfme prlce 1e flrm cfn noL se fny unlL elLer
fL f lger prlce or fL f ower prlce
upp|y curve
1e lndusLry suppy curve ls Le orlzonLf summfLlon
of Le lndlvlduf suppy curve of Le flrms 1e lndusLry
suppy curve ls upwfrd soplng curve
1e flrm cfn se fs muc qufnLlLy fs lL wfnLs fL Le
glven prlce le * 1ls ls Le equllbrlum prlce of Le
lndusLry le lnLersecLlon beLween demfnd fnd suppy
curve 1ls lmples LfL Le LoLf revenue of Le flrm
lncrefses fL f consLfnL rfLe fnd so fso Le mfrglnf
revenue
1e fverfge revenue ls fso equf Lo Le M8 fs Le
demfnd curve of Le flrm belng lnflnlLey efsLlc
ln f perfecLy compeLlLlve mfrkeL wlL frge number of
buyers fnd seers lL ls lmposslbe for Le flrm Lo
lnfuence Le prlce
rlce ouL puL deLermlnfLlon ln Le mfrkeL perlod
uemfnd deLermlned prlce
Suppy deLermlned prlce
CufnLlLy
CufnLlLy
C
C1 C2
1
2
S
u2
u1 u
S1
S2
1
2
M
n
8
S
Slnce Le qufnLlLy ouL puL wlL efc flrm ls flxed ln Le mfrkeL perlod suppy
curve ls perfecLy lnefsLlc (SC) ence Le prlce ls deLermlned ony by Le
demfnd ln Le flg1 Le suppy belng flxed lf demfnd lncrefses Le prlce woud
rlse from 1 Lo 2 ln Le second flg Le suppy of f commodlLy declnes due Lo
some refson (eg food) suppy curve slfLs Lo Le efL fnd prlce lncrefses from 1
Lo 2
llg1
llg2
r|ce output determ|nat|on |n hort run
1ree posslbllLles for fn lndlvlduf flrm ln Le
sorL run under erfecL compeLlLlon
llrm mfy efrn (l)supernormf proflL
(ll)normf proflL (lll) oss dependlng on Le
poslLlon of Le sorL run cosL curves
upernorma| prof|t Jen revenue exceeds cosL
1e equllbrlum poslLlon of Le flrm ln Le sorL
run A8M8 M8MC fnd were MC cuLs Le
M8 curve from beow
uA8M8
AC
MC
C
C1 C2

4
roflL
SorL run proflL mfxlmlslng ouLpuL ln perfecL compeLlLlon
CufnLlLy
rlce
rlce ouLpuL deLermlnfLlon under erfecL compeLlLlon short run
1ls prlce ls flxed for f Le flrms by Le lndusLry Clven Lls prlce Le flrm cfn
produce fnd se fny qufnLlLy fL Lls prlce fnd fd[usLs Le ouLpuL Lo efrn
mfxlmum proflL 1e flrm fs u sfped fverfge fnd mfrglnf cosL curves
becfuse fs qufnLlLy lncrefses C Lo C1Le AC declnes fnd Len lncrefses
beyond LfL polnL Any Llme Le flrm's prlce ls lger Lfn Le AC lL ls efrnlng
economlc proflL sown by Le fref
1

4
under erfecL CompeLlLlon slnce
Le prlce ls deLermlned by Le mfrkeL fnd Le producL ls omogeneous the
on/y decision before the Monqer is to odjust the outut not the rice le how
much to roduce?
1e proflL mfxlmlslng ouLpuL ls deLermlned were Le mfrkeL pr|ce |s [ust equa|
to the cost of product|on 1e ouL puL cfn be lncrefsed up Lo C2 were
MCrlce(A8) lf Le flrm lncrefses lLs ouLpuL beyond C2 Le revenue wl be
ess Lfn Le exLrf cosL (refecLed Lroug MC) CpposlLe wl be Le cfse lf
producLlon ls beow C2 were Le oss of revenue ls grefLer Lfn Le reducLlon
ln cosL fnd proflL declnes ence 2 outut reresents the short run
equi/ibrium where the monoqer moximises the rofit
LsLlmfLe Le sorLrun economlc proflL fnd proflL
mfxlmlslng ouLpuL of f [ulce mfker from Le
foowlng equfLlon were prlce remflns consLfnL
fL 8s 20
1C1000+2C+001C
2
MCd1C/dC 2+002C
MCA8
Lco proflL 181C
E
Normal Profit under Perfect competition
Normal Profit where
MC=AC=AR=MR.
The equilibrium
output =OQ and
price is OP at E
hort run |oss under perfect compet|t|on
AC
MC
A8uM8
C

1
M
n
1oLf oss1Mn
Loss
r|ce and Cutput determ|nat|on |n the |ong run under C
ln Le ong run Le flrms cfn fd[usL Lelr slze or qulL Le lndusLry
fnd new flrms cfn enLer Le lndusLry lf Le mfrkeL prlce ls suc
LfL A8AC Le flrms mfke supernormf proflL 1ls fLLrfcLs Le
new flrms Lo lncrefse Le suppy fL Le glven prlce fnd Lls resuLs
ln Le rlgLwfrd slfL ln Le suppy curve Llkewlse lf A8 AC Le
flrms lncur osses 1e mfrglnf flrms qulL Le lndusLry cfuslng
decrefse ln Le mfrkeL suppy fnd Lls resuLs ln efLwfrd slfL ln
Le suppy curve 1e efL wfrd slfL ln Le suppy curve rflses Le
prlce fnd rlgL wfrd slfL ln Le suppy curve pus lL down 1ls
fd[usLmenL process conLlnues Ll A8AC fnd Le flrms cfn ony
efrn normf proflL (8ef flgf fnd b)
1e equllbrlum condlLlon of Le flrm ln Le ong run
A8M8LACLMC
@he f|rm can earn on|y norma| prof|t |n the |ong run under
erfect|y compet|t|ve market
MC LMC
u'
u
S
S'
S"
S"
S'
S
uA8M8
u'A8'M8'
u"A8"M8"
C C' C"

'
"

'
"
f
b
c
C C' C"
A
8
CufnLlLy
rlce/CosL/
8evenue
8ev/
CosL
CufnLlLy
Long run prof|t max|m|sat|on output
C
n
O
xp|anat|on
lndusLry ong run demfnd curve uu fnd Suppy curveSS Le prlce ls C
LeL f flrms fve ldenLlcf LAC fnd LMC fnd fL Lls prlce f Le flrms fre
fL equllbrlum fL c were CA8M8LMC 1e economlc proflL of Le
flrm ls cn per unlL 1ls fLLrfcLs oLer flrms Lo enLer Le lndusLry fnd Le
suppy curve of Le lndusLry slfLs Lo Le rlgL Lo SS' cfuslng f ff ln Le
prlce Lo C' fnd Le flrms lf produces CC ouLpuL lL wl ffce oss So Le
flrm lnsLefd of produclng CC wl produce CC' were MCA8' 1e LoLf
proflL ere ls ess Lfn before Pence more fow of cfplLf fnd suppy
curve slfLs Lo SS" fnd equllbrlum prlce ls reduced Lo " fnd demfnd
curve of Le flrm becomes u" Pere Le rlce or A8"MCAC fnd Le flrms
fverfge revenue ls [usL equfs Lo AC 1e flrm ls efrnlng f normf proflL
fnd Lere ls no economlc proflL no flrm mfkes supernormf proflL nor
fny of Lem lncur osses fL Lls polnL Pence fL Lls polnL Lere ls no
Lendency of Le flrms Lo enLer or qulL Le lndusLry t th|s po|nt both the
|ndustry and the |nd|v|dua| f|rms are at |ong run equ|||br|um
(l) f the firm incurs /osses in the short run whot o firm
wou/d do? wi// it decide to shout down immediote/y
ond with drow from the morket? 1e fnswer ls nC
1e flrm wl prefer Lo wflL fnd flnd ouL weLer mfrkeL
condlLlons lmprove ln Le ong run lf lL conLlnues Lo
mfke osses ln Le ong run Le flrm wl uLlmfLey
fve Lo efve Le lndusLry
(ll) ow does o firm decide whether to continue
roduction in site of incurrinq /osses or to shut down
oerotions? As ong fs Le prevfllng prlce ls more Lfn
Le fverfge vfrlfbe cosL (AvC) of producLlon Le flrm
wl conLlnue producLlon Jen AvC A8 Le flrm
woud suL down
M
n
C' C

'
C
CuLpuL
rlce
Jen rlce ls C lL
covers Le LoLf cosL
fnd efrns normf
proflL Jen prlce ls
C' lL covers Le
vfrlfbe cosL fnd
mlnlmlses Le osses
Jen prlce ls ess Lfn
C' lL wl noL cover Le
AvC fnd suL down
ence when the firm
oerotes ot /ess thon
its 4vc it wi// shut
down its oerotion
$hort down condition of the firm
JlL foowlng equfLlon
1vC200C20C
2
+2C
3
deLermlne fL wfL prlce of Le ouLpuL
Le flrm mfy declde Lo suL down lLs
operfLlon?
MCd1vC/dC
AvC
MCAvC