CHAPTER

22
PERFECT
COMPETITION

ECONOMICS
Roger A. Arnold • Thirteenth Edition

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 22-1 The Theory of Perfect Competition

22-2 Perfect Competition in the Short Run

22-3 Perfect Competition in the Long Run

22-4 Topics for Analysis in the Theory of Perfect

Competition

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 22-1 The Theory of Perfect Competition (1 of4)

• Market Structure: The environment whose characteristics

influence a firm’s pricing and output decisions
• Perfect Competition: A theory of market structure based on
four assumptions: (1) There are many sellers and buyers; (2)
the sellers sell a homogenous good; (3) buyers and sellers
have all relevant information; (4) entry into, and exit from, the
market is easy
• 22-1a A Perfectly Competitive Firm is a Price Taker
• Price Taker: A seller that does not have the ability to
control the price of the product it sells; the seller “takes” the
price determined in the market

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 22-1 The Theory of Perfect Competition (2 of 4)

• 22-1b The Demand Curve for a Perfectly Competitive Firm is

Horizontal
• Why Does a Perfectly Competitive Firm Sell at the
Equilibrium Price?
– If it tries to charge a price higher than the market-established
equilibrium, it won’t sell any of its products
– If the firm wants to maximize profits, it does not offer to sell at
a lower price
– See Exhibit 1

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 EXHIBIT 1
The Market Demand Curve and Firm Demand Curve in Perfect
Competition

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 22-1 The Theory of Perfect Competition (3 of 4)

●  • 22-1c Common Misconceptions about Demand Curves

– Many think that all demand curves must be downward sloping,
but this is not so
– A single perfectly competitive firm’s supply is so small,
compared with the total market supply, that the inverse
relationship between price and quantity demanded cannot be
observed on the firm’s level, only on the market level
• 22-1d The Marginal Revenue Curve of a Perfectly
Competitive Firm is the Same as Its Demand Curve
– Marginal Revenue (MR): The change in total revenue (TR)
that results from selling one additional unit of output (Q)

– For a perfectly competitive firm, P = MR

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 EXHIBIT 2
The Demand Curve and the Marginal Revenue Curve for a Perfectly
Competitive Firm

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 22-2 The Theory of Perfect Competition (1 of 6)

• For the perfectly competitive firm, a price taker, price is equal

to marginal revenue (P=MR), and therefore the firm’s demand
curve is the same as its marginal revenue curve
• This section discusses the amount of output the firm will
produce in the short run
• 22-2a What Level of Output Does the Profit-Maximizing Firm
Produce?
• Profit Maximization Rule: Profit is maximized by
producing the quantity of output at which MR = MC
• Exhibit 3

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 EXHIBIT 3
The Quantity of Output That the Perfectly Competitive Firm Will
Produce

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 22-2 The Theory of Perfect Competition (2 of 6)

• 22-2b The Perfectly Competitive Firm and Resource

Allocative Efficiency
• Resource Allocative Efficiency: The situation in which
firms produce the quantity of output at which price equals
marginal cost: P = MC
• 22-2c To Produce or Not to Produce: That is the Question
• Case 1. Price is Above Average Total Cost (Ex 4a)
• Case 2. Price is Below Average Variable Cost (Ex 4b)
• Case 3. Price is Below Average Total Cost but Above
Average Variable Cost (Ex 4c)

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 EXHIBIT 4
Profit Maximization and Loss Minimization for the Perfectly
Competitive Firm: Three Cases

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 22-2 The Theory of Perfect Competition (3 of 6)

• 22-2d Common Misconceptions over the Shutdown Decision

• Even if price is below average total cost and a loss is being
incurred, a firm should not necessarily shut down; the
decision depends in the short run on whether the firm loses
more by shutting down than by not shutting down
– Even though price is below average total cost, it could still be
above average variable cost
– If it is, the firm minimizes its losses in the short run by
continuing to produce

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 22-2 The Theory of Perfect Competition (4 of 6)

• 22-2d Common Misconceptions over the Shutdown Decision

(cont)

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 EXHIBIT 5

What Should a Perfectly Competitive Firm Do in the Short Run?

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 EXHIBIT 6

Q&A about Perfect Competition

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 22-2 The Theory of Perfect Competition (5 of 6)

• 22-2e The Perfectly Competitive Firm’s Short-Run Supply

Curve
• Short-Run (Firm) Supply Curve: The portion of the
firm’s marginal cost curve that lies above the average
variable cost curve
• Short-Run Market (Industry) Supply Curve: The
horizontal sum of all existing firms’ short-run supply curves

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 EXHIBIT 7

The Perfectly Competitive Firm’s Short-Run Supply Curve

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 EXHIBIT 8
Deriving the Market (Industry) Supply Curve for a Perfectly
Competitive Market

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 22-3 Perfect Competition in the Long Run (1 of 6)

• The number of firms in a perfectly competitive market may

not be the same in the short-run as in the long-run SR: 1000
LR ;750
• 22-3a The Conditions of Long-Run Competitive Equilibrium
SR: MC=MR
• Long-Run Competitive Equilibrium: The condition in
which P = MC = SRATC = LRATC Economic profit is zero,
firms are producing the quantity of output at which price is
equal to marginal cost, and no firm has an incentive to
change its plant size

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 EXHIBIT 9

Long-Run Competitive Equilibrium

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 22-3 Perfect Competition in the Long Run (2 of 6)

• 22-3b The Perfectly Competitive Firm and Productive

Efficiency
• Productive Efficiency: The situation in which a firm
produces its output at the lowest possible per-unit cost
(lowest ATC)
• 22-3c Industry Adjustment to an Increase in Demand
• An increase in market demand for a product can throw an
industry out of long-run competitive equilibrium (Exhibit
10)

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 EXHIBIT 10
The Process of Moving from One Long-run Competitive Equilibrium
Position to Another (1 of 2)

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 22-3 Perfect Competition in the Long Run (3 of 6)

• 22-3c Industry Adjustment to an Increase in Demand (cont)

• Long-Run (Industry) Supply (LRS) Curve: A graphic
representation of the quantities of output that an industry is
prepared to supply at different prices after the entry and exit
of firms are completed
• Constant-Cost Industry: An industry in which overage
total costs do not change as (industry) output increases or
decreases when firms enter or exit the industry, respectively
• Increasing-Cost Industry: An industry in which average
total costs increase as output increases and decrease as
output decreases when firms enter and exit the industry,
respectively

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 22-3 Perfect Competition in the Long Run (4 of 6)

• 22-3c Industry Adjustment to an Increase in Demand (cont)

• Decreasing-Cost Industry: An industry in which average
total costs decrease as output increases and increase as
output decreases when firms enter and exit the industry,
respectively
• Exhibit 11
• 22-3d Profit from Two Perspectives
• From one perspective, profit serves as an incentive for
individuals to produce
• From another perspective, it serves as a signal, identifying
where resources are most welcome

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 EXHIBIT 11

Long-Run Industry Supply Curves

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