Perfect Competition

(Product Market)
 Perfect Competition

Feature of Perfect Competition: PRICE

UNIFORMITY,
throughout the market

Conditions for Per Comp

1. Large number of participants

2. Homogeneity of the units of the product
3. Free entry and exit of firms
4. Perfect knowledge among participants
5. Perfect mobility of factors
6. No transport cost
7. No government interference
 Collateral Features

1. The Industry is the PRICE-MAKER and the Firms are

PRICE TAKERS as the price of the product is determined
by market supply and demand.

2. The demand curve for the firm becomes PE at the

market determined price.

3. The firm’s objectives are limited to:

i) Maximization of profits (= Net Revenue)
ii) Being a Not-for-Profit Firm
Total, Average, and Marginal Revenue for a Competitive Firm

Quantity Price = AR TR MR
Units Rs. Rs. Rs.
1 5 5 5
2 5 10 5
3 5 15 5
4 5 20 5
5 5 25 5
6 5 30 5
7 5 35 5
8 5 40 5
SHORT RUN DYNAMICS
UNDER
PERFECT COMPETITION
 Perfect Competition. SUPERNORMAL PROFIT
Industry Firm
Rev,
Price Cost
MC
AC
S

Ei
P E
P AR / MR
T C

Qd, Qs Q Qty

At Stable Equilibrium point E: MC = MR = AR > AC

MC = MR MR = AR AR > AC

Stable Equilibrium Perfect Competition Super Normal Profits

Perfect Competition - NORMAL PROFIT PARETO OPTIMAL
Industry
Rev,
Firm SITUATION
AC
Price Cost
MC

Ei
P E
P AR / MR

Qd, Qs Q Qty
At Stable Equilibrium point E: MC = MR = AR = AC
MC = MR MR = AR AR = AC

Stable Equilibrium Perfect Competition Normal Profits

 Perfect Competition. SUBNORMAL (Continue)
Industry Firm AC AVC
Rev,
Price Cost
MC

S
T C
Ei
P E
P AR / MR

D V

Qd, Qs Q Qty

At Stable Equilibrium point E: MC = MR = AR < AC & AR > AVC

MC = MR MR = AR AR < AC AR > AVC

Stable Equilibrium Perfect Competition Sub Normal Profits Continue

 Perfect Competition. SUBNORMAL (Shut Down)
Firm AC
Industry Rev, MC AVC
Price Cost
C
S T

Ei V
P
P
E AR / MR

Qd, Qs Q Qty

At Stable Equilibrium point E: MC = MR = AR < AC & AR < AVC

MC = MR MR = AR AR < AC AR < AVC

Stable Equilibrium Perfect Competition Sub Normal Profits Shut-Down

 Rev,
Cost
• If (AR = P ≥ AVC(min)), then the firm could
still produce, in spite of its TR < TC

MC

AC

• If AR = P < AVC(min), the

AVC
firm should shut down
P
P = AVC = AR =MR

Q Qty
 AC Firm
Firm Firm Firm
Industry
AC
AVC Rev,
Price Rev, Rev, Rev, Cost MC
Cost Cost MC
Cost MC
AC
MC
LAC AC

AVC
S AVC AVC
T
Ei C
T C P E
P V P AR / MR
P
P E E
E T C

V V

V
D

Q Qty
Qd, Qs Q Qty Q Qty Q Qty
Rev, Rev,
Cost Cost
MC
AC
AC
MC

P R
P E
AR / MR C
T
T
C
E
MR AR

Q Qty
Q Qty
A firm has a total cost function

C = (0.1)(q ) – 3q + 50q + 100.

3 2

The market price is Rs 100/3 per unit of q.

Find ...
 LONG RUN DYNAMICS
UNDER
PERFECT COMPETITION
 Perfect Competition. SUPERNORMAL to NORMAL Profits

Industry Firm
Rev,
Price Cost
AC
So
1 Sn

Eio Po
Po ARo / MRo
2 3
Pn
Pn ARn / MRn
Ein
D

Qd, Qs Qty
 Perfect Competition. SUBNORMAL to NORMAL Profits

Industry Rev, Firm

Price Cost AC

D Sn

1 So
Ein Pn
Pn ARn / MRn
2 3
Eio
Po ARo / MRo
Po

Qd, Qs Qty
 ENTRY of firms > EXIT of firms. CASE A
Rev,
Price Sn Cost
AC
So
SF

Eio Po
Po ARo / MRo
Pn
Pn ARn / MRn
EiF
D

Qd, Qs Qty
Industry Firm
 ENTRY of firms > EXIT of firms. CASE B
Rev,
Price Cost
AC
So
SF
Sn
Eio Po
Po ARo / MRo
Pn
Pn ARn / MRn
EiF
D

Qd, Qs Qty
Industry Firm
 ENTRY of firms < EXIT of firms. CASE C

AC
Industry Firm
Rev,
Price Cost
SF
So Sn

EiF PF
Pn ARF / MRF
Po ARo / MRo
Eio Po

Qd, Qs Qty
 ENTRY of firms < EXIT of firms. CASE D

Industry

Sn AC
Firm
Rev,
Price Cost
SF
So

EiF PF
Pn ARF / MRF
Po ARo / MRo
Eio Po

Qd, Qs Qty
IMPACT OF TIME ON PRICES
UNDER
PERFECT COMPETITION
 Perfect Competition. Impact of Time on Prices and Markets
Smp
Ssr
Price
Slr

Emp
Esr
Pmp > Psr > P lr

Elr
Qmp < Qsr < Qlr

Qmp Qsr Qlr Qd, Qs

Perfect Competition: Impact of Time on Prices - Demand Increases

Smp Ssr
Price

∆ Pmp > ∆ Psr > ∆ P lr

Empn
Slr
Esrn
Empo Esro

Elrn
Elro

∆ Qmp < ∆ Qsr < ∆ Qlr

Dn
= ∆Qlr
Do
= ∆Qsr

Qmp Qsro Qlro Qlrn

Qd, Qs
Qsrn
Perfect Competition: Impact of Time on Prices - Demand Decreases
Price
Smp Ssr

∆ Pmp > ∆ Psr > ∆ P lr

Empo
Slr
Esro
Empn Esrn

Elro
Elrn
∆ Qmp < ∆ Qsr < ∆ Qlr
Do
= ∆Qlr
Dn
= ∆Qsr

Qmp Qsrn Qlrn Qlro

Qd, Qs
Qsro
 MARKET DYNAMICS
UNDER
PERFECT COMPETITION
Case No. A B Comments

1 dd = K & ss INC dd = K & ss DEC

1 variable constant & the
other changes
2 dd INC & ss = K dd DEC & ss = K

3 dd INC > ss INC dd DEC > ss DEC

Both variables change in
the SAME DIRECTION but in
4 dd INC < ss INC dd DEC < ss DEC DIFFERENT PROPORTIONS

5 dd INC > ss DEC dd DEC > ss INC

Both variables change in
DIFFERENT DIRECTIONS &
in
6 dd DEC < ss INC dd INC < ss DEC DIFFERENT
Both variablesPROPORTIONS
change in
the SAME DIRECTION &
7 dd INC = ss INC dd DEC = ss DEC
SAME
PROPORTIONS
Both variables change in
8 dd INC = ss DEC dd DEC = ss INC the SAME DIRECTION but in
DIFFERENT PROPORTIONS
 Case Nos. 1B
Case Nos. 1A

DD = K & SS DD = K & SS

Price Price Sn

So So
Sn
Pn En
Po Eo Po Eo
Pn En

Do Do

Qo Qn Qd, Qs Qn Qo Qd, Qs

Price falls & Qty increases Price rises & Qty decreases
 Case Nos. 2A Case Nos. 2B

SS = K & DD SS = K & DD

Price Price

So So
Pn
En Po Eo
Po Eo Pn En

Dn Do
Do Dn

Qo Qn Qd, Qs Qn Qo Qd, Qs

Price rises & Qty increases Price falls & Qty decreases
 Case Nos. 3A Case Nos. 3B

SS SS DD
DD

Price Price
Sn
So
So
Sn
Po Eo
Pn En Pn En
Po Eo

Dn Do
Do Dn

Qo Qn Qd, Qs Qn Qo Qd, Qs

Price rise < increase in Qty Price fall < decrease in Qty
 Case Nos. 4A Case Nos. 4B

SS SS DD
DD

Price Price Sn

So En So
Pn
Sn Eo
Po Eo Po
Pn En
Do
Dn Dn
Do

Qo Qn Qd, Qs Qn Qo Qd, Qs

Price fall < the increase in Qty Price rise < the decrease in Qty
 Case Nos. 5A Case Nos. 5B

SS SS DD
DD

Price Price

So
Sn
Sn
En So
Po Eo Pn

Pn En Po
Do Eo Dn
Dn
Do

Qn Qo Qd, Qs
Qo Qn Qd, Qs

Price fall > the decrease in Qty Price rise > the increase in Qty
 Case Nos. 6A Case Nos. 6B

SS SS DD
DD

Price Price
Sn
So
Sn Pn En So

Po Eo Po Eo

Pn En Dn
Do Do
Dn

Qo Qn Qd, Qs Qn Qo Qd, Qs

Price fall > the increase in Qty Price rise > the decrease in Qty
 Case Nos. 7A Case Nos. 7B

SS SS DD
DD

Price Price Sn
So
So
Sn
En
Eo Po Eo
Po En

Dn Do
Do Dn

Qo Qn Qd, Qs Qn Qo Qd, Qs

Price = K & Quantity increases Price = K & Quantity decreases

 Case Nos. 8A Case Nos. 8B

SS SS DD
DD

Price Price Sn

So Pn So
En
Po Sn
Eo
Po Eo
Pn En
Do Dn
Do
Dn

Qo Qd, Qs Qo Qd, Qs

Price falls & Quantity = K Price rises & Quantity = K

Case No. A B Comments

1 dd = K & ss INC dd = K & ss DEC

1 variable constant & the
other changes
2 dd INC & SS = K dd DEC & ss = K

3 dd INC > ss INC dd DEC > ss DEC Both variables change in

the SAME DIRECTION but in
4 dd INC < ss INC dd DEC < ss DEC DIFFERENT PROPORTIONS

Both variables change in

5 dd INC > ss DEC dd DEC > ss INC
DIFFERENT DIRECTIONS &
in
6 dd DEC < ss INC dd INC < ss DEC DIFFERENT PROPORTIONS
Both variables change in
the SAME DIRECTION &
7 dd INC = ss INC dd DEC = ss DEC
SAME
PROPORTIONS
Both variables change in
8 dd INC = ss DEC dd DEC = ss INC the SAME DIRECTION but in
DIFFERENT PROPORTIONS
Find the % changes in price & quantity when
demand increases & supply decreases, given the
following extractable (shuffled) demand & supply
functions:

pd1 - 105 + 0.7qd1 = 0

ps1 - 15 - 0.4qs1 = 0
pd2 - 75 + 0.7qd2 = 0
ps2 - 21 - 0.4qs2 = 0
THE NOTION OF PRODUCTION EFFICIENCY

UNDER
PERFECT COMPETITION
 Derivation of a Firm's Supply Curve

Rev,
Price
Cost AVC
MC S
E3 P3 S3
P3
AR3 / MR3

E2 P2 S2
P2
AR2 / MR2
E1 P1 S1
P1
AR1 / MR1
E0 P0 S0
P0
AR0 / MR0

Q0 Q1 Q2 Q3 Qty Q0 Q1 Q2 Q3 Qs
 The Shutdown Decision Graphically:
Rev,
Cost The MC function is the SS curve,
subject to AR ≥ AVC
MC / SS

AC

AVC

P
Shutdown P = AVC = AR =MR

Qty
 Derivation of the industry's supply curve EQUALLY EFFICIENT FIRMS
Qi = Qa + Qb + Qc
Firm A Firm B Firm C
Industry
SB SC SI
SA
Price Price Price Price

P0
P0 P0 P0

Qa Qty Qb Qty Qty Qi Qty

Qc
(100)

Derivation of the industry's supply curve UNEQUALLY EFFICIENT FIRMS

Qi = Qa + Qb + Qc
Firm A Firm B Firm C
Industry
SB SC
Price SA Price Price Price SI

P0
P0 P0 P0

Qa Qty Qb Qty Qc Qty Qi Qty

(100)
The Total Cost function of a firm is:

C = 5q + 2q + 10
2

find the supply function of this firm