Managerial Economics and Financial Analysis

Unit – 3 Module – 3.2

Perfect Competition

Mrs. K.V.S.Praveena
Assistant Professor
Vignan’s Institute of Information
Technology
Managerial Economics and Financial Analysis

Contents
• Perfect Competition
• Perfect Market
•Features of Perfect Competition
• Price – output Determination
• Short run
• Long run
 Managerial Economics and Financial Analysis

Perfect Competition
&
Perfect Market

A market structure in which all firms in an

industry are price takers and in which there
is freedom of entry into and exit from the
industry is called Perfect Competition.

The market with Perfect Competition

conditions is known as Perfect Market.
 Managerial Economics and Financial Analysis

Features of Perfect Competition

1. Large no. of sellers

2. Large no. of buyers
3. Homogeneous products
4. Freedom to enter or exit the market
5. Perfect information available to buyers & sellers
6. Perfect mobility of factors of production
7. Each firm is a price-taker
 Managerial Economics and Financial Analysis

Price - output determination under Perfect Competition

• While discussing price determination under Perfect

Competition it should be clear between the Industry
and Firm.
• According to one of the features of Perfect Competition
firm is the price taker; which means firms are not free
to determine their own prices.
• Prices are determined on the basis of market demand
and market supply.
• Economically under Perfect Competition price is
determined by the intersection of market demand and
market supply curve.
 Managerial Economics and Financial Analysis

Price determination under Perfect Competition for

SHORT RUN

Certain Assumptions:
• Under perfect competition Price determined by the
market
• In short run one can make any changes in variable
factors but it does not allow any change in fixed
factors.
• Every firm under perfect competition produces
same cost curve.
• Under perfect competition for short run always the
demand curve and average revenue curve will
be one and a same.
 Managerial Economics and Financial Analysis

• Firm sales additional units at the same price so that

average revenue curve and marginal revenue curve
will be one and a same.
• Avg. cost curve and Marginal cost curve as usual
found normally as “U” shaped.
• In short run there are three possibilities as below to
earn profit:
i. Super Normal Profit
ii. Normal Profit
iii. Sub Normal Profit
• After attaining the equilibrium the firm will not
increase or decrease its output.
Equilibrium = MR = MC
Managerial Economics and Financial Analysis
 Managerial Economics and Financial Analysis

Price determination under Perfect Competition for

LONG RUN
• Long run is that period which allows change in each
and every factor.
• Firm can adjust supply according to the change in
demand.
• The firm may change the size or scale of operation
to reduce the cost.
• It can be possible that some firms may leave the
market.
• As a result supply becomes perfectly elastic and
therefore supply will change with the change in
price.
• In long run firm will earn only NORMAL PROFIT.
 Managerial Economics and Financial Analysis

• Price will be fixed by the industry by intersection

point of market demand and supply.
• Asthe firm earns Normal profit so we can
see in the diagram that AR = AC.
 Managerial Economics and Financial Analysis

• Now suppose that the price is fixed at OP2 than the

revenue will increase and this will give super
normal profit and due to super normal profit of the
existing firm other entrepreneurs will also get
interested to enter in to the market.
• At the same time new firms will start producing
same commodities.
• As a result supply will get increased while demand
remains constant so price will be reduced from OP2
to OP1.
• Thus firms in short run earning supernormal profit
will start earning normal profit in long run.
 Managerial Economics and Financial Analysis

• This happens only in long run because in short run

neww entry is not possible.
• Now suppose the price is fixed at OP3 and
firms are earning subnormal profit in short run.
• At the same time, some firms may leave
the market because of subnormal profit.
• This will resulted in supply decrease and demand
remains constant .
• This situation will lead to increase in the price from
OP3 to OP1.
Managerial Economics and Financial Analysis

Summary
• What is a Perfect Competition
• Features of Perfect Competition
• Price – Output determination
• Short-run
• Long-run
 Managerial Economics and Financial Analysis

Quiz
1. In a Perfect market, there is perfect
------- of factors of production.
2. A market in which there is freedom of entry and
exit for the traders is called ---------
3. In Perfect Competition, price and marginal revenue
are ----------
Answers
1. Mobility 2. Perfect market 3. one and the same
Managerial Economics and Financial Analysis

Thank you