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FINC304

Managing in a Competitive
Environment

Session 8– Perfect Competition

Lecturer: Dr. Agyapomaa Gyeke-Dako, UGBS


Contact Information: agyeke-dako@ug.edu.gh

College of Education
School of Continuing and Distance Education
2014/2015 – 2016/2017
Session Overview
• Having obtained a firm understanding of the different
components of profit, which is revenue and cost, we are now
ready to select the price and the output that the firm needs to
maximize profit. Having done that, we will calculate the extent
of profit a firm makes. Because firms belong to different
markets which may have different structures, we look at the
different markets separately. In this session, we examine the
profit conditions in a competitive market.

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 2


Session Outline
The key topics to be covered in the session are as follows:
• Characteristics of the Perfectly Competitive Markets
• Perfect Competition in the Short Run
• Perfect Competition in the Long Run

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 3


Reading List
• Baye Michael and Price Jeffery: Managerial
Economics and Business Strategy, 8th Edition

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 4


Perfect compet1t1on ;J td r\on
Long Run

Different Markets Compared


• Let us first compare the different markets based on
certain characteristics
Characteristic Perfect Monopolistic Oligopoly Monopoly
Competition D
Competition
Number of firms Large number Large number Small number Single firm
Dko
competing
Nature of the Undifferentiated Differentiated Undifferentiated Unique
product or differentiated
Entry No barriers Few barriers Many barriers Blocked

Information Complete Relatively good Asymmetric Asymmetric


availability
Firm' s control None Some Some Substantial
over price

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 5


Perfect Competition
• From the Table, the characteristics of perfect competition are
• Many small firms.
• Firms produce homogeneous/identical products
• These two mean each firm is so small to influence the price
of the product (Price- taker: Refer to Session 6)
• Buyers and sellers have perfect information /
knowledge
• Free entry and exit
• There are no transaction costs

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 6


Perfect Competition
• Each firm is a price taker
• The demand curve for each firm is horizontal,
same as average revenue and marginal revenue
• perfectly price elastic (Refer to session 6)

• The demand for the industry remains downward


sloping

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 7


Profit Maximisation

I t " JJ +r '1
Pt<rtt<•'t ,· rrr ....t rt r rr Short-Run

Price takers: firm & market Demand Curves

Price Price

P, P, t - - - - - - - - D=AR=MR

o·L------------------ O·
L--------------------
o, Output ( 0 ) Output (Q )

(a) Market (Industry) (b) Firm

..... M anagtn al Economtcs Lecture five


Dr. Agyapomaa Gyeke-Dako

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 8


Profit Maximisation

P r t t > d C<_lfltf:t>tttt,_ln rtR r


I I f I

Profit maximisation: firm vs market

Pnce(PI M arket Demand and Pnc:e(PI Individual Firm' s Costs and


Sup ply Revenues
MC (Supply)

Uar1<.et
Demand

Q1 Output(Q) Q2 Output(Q)

Dr. Agyapomaa Gyeke-Dako

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 9


Profit Maximisation

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Scenarios for Short Run
• In the short run, a perfectly competitive firm can
have four scenarios
• Make abnormal (economic) profit
• Make normal profit
• Make a loss
• Can be in a situation when it has to shut down

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 11


Profit Maximisation

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Profit Maximisation
• 𝜋 = 𝑇𝑅 − 𝑇𝐶 = 𝑃 ∗ 𝑄 − 𝐶(𝑄)
𝑑𝜋 𝑑(𝑃∗𝑄) 𝑑𝐶 𝑄 𝑑𝐶(𝑄)
• =0= − =0=>𝑃− = 0 > 𝑃 = 𝑀𝐶
𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑑𝑄
𝑑2 𝜋 𝑑𝑃 𝑑𝑀𝐶 𝑑𝑀𝐶 𝑑𝑀𝐶
• = − <0=>− <0=> >0
𝑑𝑄2 𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑑𝑄

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 13


Loss but shut down or no shut down

•When P = AVCmin or shut down point, the firm


can continue to produce & supply since it’s
profitable.

• But below P = AVCmin, it is more profitable for the


perfectly competitive firm to shut down than to
continue to produce.

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Long Run Adjsutments
• A rise in industry demand will result in a
positive economic profit for a perfectly
competitive firm.
• The assumptions that 1) market participants have
perfect (complete) info and
2) there are no barriers to entry ensure that LR
• profits = 0.
• So long as economic profits (losses) exist, firms
will enter (leave) the market.
Only when LR π = 0 will there be no more
incentive for entry or exit.
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Long Run Adjustment
• Perfect info ensures that each firm has access to the
least-cost method of production
• In the Long Run, P=MC
• P=min AC

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Algebraic Example
• Consider the firm with the following total monthly
cost function, which includes a normal profit.

TC = 1000+ 2Q+0.01Q2.
The firm operates in a perfectly competitive industry
and sells its product at the market-determined price of
$10. To maximize total profits, what should be the
firm’s monthly output level, and how much economic
profit will the firm earn each month?

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Algebraic Example
• Procedure
1. First determine the firm’s marginal cost function by
taking the first derivative of the total cost function
with respect to Q.
2. Under perfect competition, profit is maximized by
setting MC=P
3. Find economic profit=TR-TC

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