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# perfect

competition
Oktaviani Charra
Maura B. Alexandrina
CONCEPT
Perfect competition is
a market in which

## • many firms sell identical

• there are no restrictions on entry
• established firms have no
• sellers and buyers are well
• the firms are price takers
How does it arise?
If the minimum efficient scale of a
single producer is small relative to
the market demand for the good or
service.

producers.

## The market act in perfect

competition manner.
producer would produce at
minimum efficient scale

## Parkin, Michael, 2012, Economics, 10th

Edition, Pearson Education Ltd.,
Global Edition
Revenue
TR = P x Q
MR = P = AR = D for firm’s product
D is horizontal
Firm’s Decision

## • How to produce at minimum cost?

 Producing at minimum efficient
scale when the LRAC is at minimum.
• What quantity to produce
 MR = MC
• Whether to enter or exit the market
 Shutdown decision
Firm’s Output
Decision

TOTAL ANALYSIS
• Produces at the quantity
when the economic profit
is the highest
• Which is when TR curve
is above the TC curve and
at the largest gap
Firm’s Output Decision

MARGINAL ANALYSIS
Producing at maximum profit
 MC = MR

## Then what happen when the occurring

price rises?
 Firm would increase production.
 Reflect the law of supply.
Firm’s Output
Decision

• Producer would
continue to produce
until they get all the
profit from each goods
produced, which stops
at the MR=MC point.
• In the graph, after the
output would result in
loss.
Shutdown Decision
• At MC = MR, when P < ATC, the firm
experiences economic loss.
• Economic Loss = TFC + (AVC – P) x Q
• Firm compare the loss between:
• Shutting down, Total Loss = TFC
• Keep producing and see if TR can cover
TVC.
• Therefore…
• TFC > TR > TVC keep producing
• TFC, TVC > TR shut down
Firm’s
Shutdown
Decision
• Below the shutdown point,
the firm shuts down.
• At the shutdown point, it’s
indifferent between shutting
down and producing.
Because any revenue
Shutdown point is wouldn’t cover the AFC.
the minimum AVC. • Above the shutdown point,
the firm produces loss-
minimizing output and
incurs a loss less than TFC.
Firm’s Supply Curve
is derived from the MC and AVC

MR = MC

## • P < minimum AVC, produce no

output & temporarily shut down.
 After few markets shut down and get out
MC from the market, the supply decrease and the
reflects price would rise again.
supply
curve
• P = minimum AVC, temporarily
Shutdown shut down or produce output at
point minimum AVC
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition
OUTPUT,
PRICE,
PROFIT
Short-Run
Market Supply
Curve

## • At prices below \$17, all

firms shut down. The
quantity supplied is zero.
• At \$17, each firm is
indifferent between
shutting down or
producing. All firms may
produce 0 to 7000
sweaters.
Output & Price
at Equilibrium
in the Short Run
• Remember S reflects MC.
• The Equilibrium price is
given price that would
determine the MR.
• Profit maximizing output
is at the equilibrium. It’s
when MC = MR.
• Equilibrium gives the
profit maximizing
output.
Output & Price
at Equilibrium
in the Short Run
• Shift or change in demand
would change the
Equilibrium.
• The Equilibrium price
would change. Which
means the MR also
changes.
• The MR=MC point moves.
• The supply would move as
well.
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition

## Profit or Loss in the Short Run

• Producing at profit maximizing output won’t
necessarily result in profit.
• There’s ATC to be considered.  (P-ATC) x Q
Entry & Exit in the Long Run
• New firms enter market when existing
firms are making profit
 P at (MC=MR) > ATC
 market price falls and profit decrease
• Firms exit market when they are
incurring loss.
 market price rises and loss decrease
• Entry and exit stop when firms
make zero economic profit. This
is the long run equilibrium.
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition

## Entry & Exit

in the Long Run
Increase in Demand
• Initially increasing price
• Higher price attracts new firms to enter
• Firms keep entering until price return
at zero economic profit
Decrease in Demand
• Initially decreasing price below zero
economic profit (loss)
• Loss attracts firms to exit
• Firms keep exiting until price return
at zero economic profit
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition

Example for
Decrease in Demand
Change in Supply

## • First firm to use new technology make

economic profit
• More firms use new technology
• Supply increase and lower the price
• Firms that use old technology with the
new lower price incur economic loss
from zero economic profit
• Old technology firms exit
PERFECT
COMPETITION
EFFICIENCY
Efficient Use of Resources

## • Resource use is efficient when we

produce the goods and services that
people value most highly
• We can test whether resources are
allocated efficiently by comparing
marginal social benefit and marginal
social cost
Choices

## • If the people who consume a good or service

are the only ones who benefit from it, then
the market demand curve measures the
benefit to the entire society and is the
marginal social benefit curve.
• If the firms that produce a good or
service bear all the costs of producing
it, then the market supply curve is the
marginal social cost curve.
Equilibrium and
Efficiency

## • Resources are used efficiently when

marginal social benefit equals
marginal social cost.
• Total surplus : consumer surplus +
producer surplus
• When the market for a good or service
is in equilibrium, the gains from a
Efficiency in a
Market
• Consumers get most
value from their
budgets at all points
on the market
demand curve.
• D = MSB.
• Producers get most
value out of their
resources at all points
on the market supply
curve.
• S = MSC.
Efficiency in a
Market
/ATC

## • Each firm would make

zero economic profit
• Each firm would
produce at the lowest
possible LRAC.