Of the Market structures that we will study

1. Perfect competition.
2. Monopoly.
3. Monopolistic competition .
4. Oligopoly.
5. Duo goploy.
Perfect Competition

Chapter 23
 Perfect Competition
• A perfectly competitive market is one in which economic forces operate
unhindered.

• A perfectly competitive market must meet the following requirements:

 Both buyers and sellers are price takers.
 The number of firms is large and so are the customers.
 There are no barriers to entry and Exit.
 The firms’ products are identical.
 There is complete information.
 Firms are profit maximizers.
 Comments on the Demand Curves for
the Firm and the Industry
• The demand curves facing the firm is different from the
industry demand curve.
• A perfectly competitive firm’s demand schedule is perfectly
elastic even though the demand curve for the market is
downward sloping.
Demand Curve – Competition
Costs

60
50
40
D = AR = MR = P
30
20
10
0
1 2 3 4 5 6 7 8 9 10 Quantity
 Marginal Cost---
Cost--- Supply Curve
Costs MC
When a firm operates in a
perfectly competitive
60
market,
it’s supply curve 50
is that portion of its short-run 40 A C P = D = MR
Marginal cost curve B = AR
30 A
above average variable cost.
20
10
0
1 2 3 4 5 6 7 8 9 10 Quantity
 How does a firm Maximizes profit

• The goal of the firm is to maximize profits.

• Two ways :
• Marginal using MR-MC
• Formula Profit is the difference between total
revenue and total cost
• Three points to consider :
• The equilprium point .
• The shut down point .
• The breakeven point
 How to Maximize Profit
• To maximize profits, a firm should produce where marginal
cost equals marginal revenue.
MC = MR
• The supplier will cut back on production if marginal cost is
greater than marginal revenue.

 Thus, the profit-

profit-maximizing condition of a
competitive firm is
MC = MR = P.
 Firms Maximize Total Profit
• Firms seek to maximize total profit, not profit per unit.
– Firms do not care about profit per unit.
– As long as increasing output increases total profits, a
profit-maximizing firm should produce more.

• Find output where MC = MR.

– The intersection of MC = MR (P) determines the quantity
the firm will produce if it wishes to maximize profits.
 The Shutdown Point
• The firm will shut down if it cannot cover average variable costs.
– A firm should continue to produce as long as price is greater than
average variable cost.
– If price falls below that point it makes sense to shut down
temporarily and save the variable costs.

• The shutdown point is the point at which the firm will be better
off it it shuts down than it will if it stays in business.
• If total revenue is more than total variable cost, the firm’s best
strategy is to temporarily produce at a loss.
• It is taking less of a loss than it would by shutting down.
 The Shutdown Decision

MC
Price
60

50 ATC

40 Loss
P = MR
30
AVC
20
17.50 A
10

0
2 4 6 8 Quantity
Short--Run Market Supply and Demand Perfect competition
Short

• The market supply curve is the horizontal sum of all the

firms' marginal cost curves, taking account of any changes
in input prices that might occur
 Market Response to an Increase in Demand
Response on Demand and supply ( Price stability )

Price Market Price Firm

MC
S0SR
S1SR AC
B B
9 9
C Profit
7 SLR 7
A
A

D1
D0
0 700 840 1,200 Quantity 0 1012 Quantity
 Long--Run Market Supply and Demand
Long
Perfect competition

From Short-Run Profit To Long-Run Equilibrium

Market Firm
With initial supply
S1 curve S , market So each firm
Price 1 Price
price is 4.50… earns an
economic profit. MC
A
A
4.50 4.50 d
ATC 1

900,000 9,000

Lieberman & Hall; Introduction to Economics, 2005

 From Short-Run Profit To Long-Run Equilibrium

Market Firm

Price S1 S2
Price
MC
A
A
4.50 4.50 d
ATC 1

E E
2.50 2.50 d1
D

900,000 1,200,000 5,000 9,000

Profit attracts entry, shifting until market price falls to 2.50 and each
the supply curve rightward… firm earns zero economic profit.

Lieberman & Hall; Introduction to Economics, 2005

15
 Long--Run Competitive Equilibrium
Long
• Profits and losses are inconsistent with long-run equilibrium.
– Profits create incentives for new firms to enter, output will increase, and
the price will fall until zero profits are made.
– The existence of losses will cause firms to leave the industry.

 The zero profit condition defines the long-run equilibrium of a competitive

industry.
Refer to the the figure. Profits
will equal zero
A) when the price equals 1.
B) when the price equals 2.
C) when the price equals 4.
D) at prices between 1 and 2.

Refer to the the figure. Profits

will be positive
A) when the price equals 1.
B) when the price equals 2.
C) at prices between 1 and 2.
D) when the price is above 2.
Refer to the figure. The firm will just be covering all of its variable
cost but none of its fixed cost
A) when the price equals 1.
B) when the price equals 2.
C) when the price equals 4.
D) at prices between 1 and 2.

Refer to the figure. Profits will be negative

A) when the price equals 2.
B) when the price is above 2.
C) when the price is below 2.
D) only when the price equals 1.

Refer to the figure. The firm's short-run shutdown price is

A) at 1.
B) at 2.
C) at 4.
D) above 4.
 Long--Run Competitive Equilibrium
Long

MC
Price
60
50
SRATC LRATC
40
P = MR
30
20
10
0 2 4 6 8 Quantity
 An Increasing-Cost Industry
INITIAL EQUILIBRIUM
Market Firm
Price NIS
S1 MC

ATC1

P1 P1 d1 = MR1
A A

D1

Output q1 Output
Q1

Lieberman & Hall; Introduction to Economics, 2005

 An Increasing-Cost Industry
NEW EQUILIBRIUM

Market Firm
Price NIS
S1 B MC
PSR B S2 PSR d = MRSR
ATC2 SR
SLR C
P2 ATC1d = MR
C P2 2 2

P1 P1 d1 = MR1
A A
D2

D1

Output q1 q1 q1 Output
Q1 QSR Q2

Lieberman & Hall; Introduction to Economics, 2005

 An Increase in Demand
• An increase in demand leads to higher prices and higher profits.
– Existing firms increase output.
– New firms enter the market, increasing output still more.
– Price falls until all profit is competed away.
 An Increase in Demand

• If input prices remain constant, the new equilibrium will be at the original
price but with a higher output.

 The original firms return to their original output but since there are more
firms in the market, the total market output increases.

Long--Run Market Supply

Long
• In the long run firms earn zero profits.
• If the long-run industry supply curve is perfectly elastic, the market is a
constant-cost industry.
 Two other possibilities exist:

 Increasing-cost industry – factor prices rise as new firms enter the

market and existing firms expand capacity.
 Decreasing-cost industry – factor prices fall as industry output
expands.
 An Increasing-
Increasing-Cost Industry
• If inputs are specialized, factor prices are likely to rise when the increase in
the industry-wide demand for inputs to production increases.

 This rise in factor costs would force costs up for each firm in the industry
and increases the price at which firms earn zero profit.

 Therefore, in increasing-cost industries, the long-run supply curve is upward

sloping.