TM – 1

Lecture 8

Market Structure
Perfect Competition, Important
Features

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 2

Perfect Competition (PC)

• 1. HORIZONTAL FIRM demand curve-firm faces
a horizontal demand curve as it has no control
or influence over market price. It is a “price
taker.” “ATOMISTIC” competition among firms
selling a HOMOGENEOUS PRODUCT
• 2. Cost curves are U-shaped except for AFC.
• 3. Price is identically equal to Marginal Revenue,
i.e., P=MR
• 4. LR equilibrium condition P=min AC which
implies zero profit condition in the LR due to
FREE ENTRY and EXIT in the long-run
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.
TM – 3 Chapter 8
Figure 8-1

Demand Curve Is Completely Elastic

for a Perfectly Competitive Firm

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 4

SUPPLY RULE under P.C.

• Competitive supply is where PRICE
EQUALS MARGINAL COST, i.e.,
• P=MC

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 5

Why does this supply rule under

PC make sense?
• Note that this should make intuitive sense
since P under perfect competition is the
same as MARGINAL REVENUE or MR.
Thus P=MC is the same as MR=MC, i.e.,
the extra revenue obtained from selling
one extra unit of output is the same as the
extra cost incurred in producing the extra
unit of output.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 6 Chapter 8
Table 8-1

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 7 Chapter 8
Figure 8-2

Firm’s Supply Curve Is Its Rising

Marginal Cost Cure

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 8

SHUTDOWN PT.
• Min Pt. of the AVC is the SHUTDOWN PT.
• In other words, if P falls below MIN AVC,
the firm will produce nothing since losses
are greater than fixed costs and revenues
cannot cover even variable costs.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 9 Chapter 8
Figure 8-3

Firm’s Supply Curve Travels Down

the MC Curve to the Shutdown Point

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 10

The FIRM’S SUPPLY CURVE

• This means that the rising portion of the
MC curve is the FIRM’S SUPPLY CURVE.
• Note shape of the supply curve below
shutdown pt.
• NOTICE that just because a firm supplies
some output, it is not necessarily making a
profit.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 11

• Compare the firm’s supply curve with the

ZERO PROFIT or BREAK EVEN condition
at the MIN PT of the AC CURVE.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 12 Chapter 8
Figure 8-3

Firm’s Supply Curve Travels Down

the MC Curve to the Shutdown Point

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 13

• Why should the firm continue producing

even if it is not making a profit along the
segment MM’?
• Because it will be MINIMIZING its
LOSSES if it does so. If it does not
produce, it would lose its entire fixed cost
which is larger than what it would lose if it
produced something. As long as P >MIN
AVC, it will produce something.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 14 Chapter 8
Figure 8-4

Add All Firms’ Supply Curves to

Derive Market Supply

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 15 Chapter 8
Figure 8-11

At Competitive Equilibrium Point E, the Marginal Costs

and Utilities of Food Are Exactly Balanced

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 16

PARETO EFFICIENCY or Allocative

Efficiency
• Every competitive equilibrium is Pareto
efficient.
• This means that it is not possible to
reallocate resources so that anyone can
be made better off without making
someone else worse off.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 17

At COMPETITIVE
EQUILIBRIUM
• Note that there are consumer surplus and
producer surplus at the competitive
equilibrium pt. E.
• The sum of these surpluses is
“ECONOMIC SURPLUS” or the total gain
from production in this industry. Economic
efficiency means that economic surplus is
maximized. Beyond pt. E, there would be
economic losses.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 18 Chapter 8
Figure 8-12

Competitive Market Integrates Consumers’

Demands and Producers’ Costs

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 19

ROLE of MC PRICING under PC

• Central Role of MC Pricing in attaining an
efficient allocation of resources. It means
that the economy is squeezing the
maximum output and satisfaction from its
scarce resources, GIVEN the amount of its
resources and the state of technology.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

TM – 20

QUALIFICATIONS
• MARKET FAILURES spoil the idyllic
picture assumed in the discussion of
efficient markets.
• 1. Imperfect competition
• 2. Externalities
• 3. Imperfect Information
• These give a role to government in the
economy but Economics does not say
which option(s) the gov’t. should choose.
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.