Analysis of Perfectly

Competitive Markets
Prepared by:
Md. Sharif Hassan
Lecturer, DBA, UAP
BEHAVIOR OF A COMPETITIVE FIRM

• Analysis of perfectly competitive firms relies on two key

assumptions.
• First, we will assume that our competitive firm maximizes
profits.
• Second, perfect competition is a world of atomistic firms who
are price-takers.
 Profit Maximization
• Profits are like the net earnings or take-home pay of a business. They represent
the amount a firm can pay in dividends to the owners, reinvest in new plant and
equipment, or employ to make financial investments. All these activities
increase the value of the firm to its owners.
• Profit maximization requires the firm to manage its internal operations
efficiently (prevent waste, encourage worker morale, choose efficient
production processes, and so forth) and to make sound decisions in the
marketplace (buy the correct quantity of inputs at least cost and choose the
optimal level of output).
 Perfect Competition
• Under perfect competition, there are many small firms, each
producing an identical product and each too small to affect the
market price.
• The perfect competitor faces a completely horizontal demand.
• The extra revenue gained from each extra unit sold is therefore
the market price.
Perfect Competition
Competitive Supply Where
Marginal Cost Equals Price
 Competitive Supply Where
Marginal Cost Equals Price
• A profit-maximizing firm
will set its output at that
level where marginal cost
equals price.
Diagrammatically, this
means that a firm’s marginal
cost curve is also its supply
curve.
 Zero Point & Shutdown Rule
• The shutdown point comes where revenues just cover variable
costs or where losses are equal to fixed costs. When the price
falls below average variable costs, the firm will maximize
profits (minimize its losses) by shutting down.
• The analysis of shutdown conditions leads to the surprising
conclusion that profit-maximizing firms may in the short run
continue to operate even though they are losing money. This
condition will hold particularly for firms that are heavily
indebted and therefore have high fixed costs (the airlines being
a good example). For these firms, as long as losses are less
than fixed costs, profits are maximized and losses are
minimized when they pay the fixed costs and still continue to
operate.
 SUPPLY BEHAVIOR IN
COMPETITIVE INDUSTRIES
• The market supply
curve for a good in a
perfectly competitive
market is obtained by
adding horizontally the
supply curves of all the
individual producers of
that good.
SHORT-RUN AND LONG-RUN
EQUILIBRIUM