erfecL CompeLlLlon

ChapLer 8
W CompeLlLlon ls rlvalry among flrms
W Perfect competition ls one ln whlch flrms
operaLe unhampered
W LheoreLlcal model use Lhe model Lo analyze
markeLs by Laklng ouL some of Lhe
assumpLlons
W erfecL compeLlLlon can approxlmaLe
condlLlons and can be used Lo predlcL whaL
wlll happen ln a wlde varleLy of markeLs
W erfecL compeLlLlon ls a markeL sLrucLure wlLh
Lhe followlng characLerlsLlcs
lrms are prlce Lakers
1he number of flrms ls large
1here are no barrlers Lo enLry/exlL
1he flrms' producLs are ldenLlcal
1here ls compleLe lnformaLlon
W lrms are prlce Lakers
A price toker ls a flrm or lndlvldual who Lakes Lhe
markeL prlce as glven
n mosL markeLs households are prlce Lakers Lhey
accepL Lhe prlce offered ln sLores
W 1he number of flrms ls large
arge means LhaL whaL one flrm does has no
effecL on whaL oLher flrms do
Any one flrms ouLpuL no maLLer how much Lhey
produce ls small compared wlLh Lhe LoLal markeL
W 1here are no barrlers Lo enLry/exlL
lrms can enLer or leave Lhe lndusLry as Lhey wlsh
lrms cannoL sLop new flrms from enLerlng
or example paLenLs granLed Lo produce a cerLaln
good (medlclne)
W 1he flrms producLs are ldenLlcal/homogenous
-o brand names or markeLlng LhaL make goods
dlfferenL from anoLher
lrms cannoL sLop new flrms from enLerlng
or example paLenLs granLed Lo produce a cerLaln
good (medlclne)
W 1here ls compleLe lnformaLlon
lrms and consumers know all Lhere ls Lo know
abouL Lhe markeL prlces cosLs producLs and
avallable Lechnology
Any Lechnologlcal breakLhrough would be
lnsLanLly known Lo all ln Lhe markeL
W xamples of perfecL compeLlLlon
lnanclal markeLs eg currency markeLs
AgrlculLure eg wheaL
1he demand curves for Lhe lndusLry and Lhe flrm
ln perfecL compeLlLlon
W 1he lndusLry ln perfecL compeLlLlon has normal
demand and supply curves le producers wlll
supply more aL hlgher prlces and consumers wlll
buy less as prlce rlses
W ndusLry prlce ls and quanLlLy demanded ls C
W Slnce lndlvldual flrms are prlceLakers Lhen Lhey
wlll have Lo sell aL Lhe lndusLry prlce
JhaL wlll happen lf Lhey sell aL a hlgher prlce?
W Consumers wlll buy from anoLher flrm slnce Lhe
producLs are ldenLlcal/homogenous
lrms can sell all lL wanLs aL Lhe prlce Lherefore lL
faces a perfecLly elasLlc demand curve
1he prlce aL whlch lL sells ls slmply Lhe equlllbrlum
prlce where Lhe lndusLry supply equals Lhe
lndusLry demand (prlceLaker)
W roflL maxlmlzlng ouLpuL ls where MC M8
W Addlng Lhe marglnal cosL curve lL ls where Lhe
MC curve crosses M8 curve from below
roflL maxlmlzaLlon for Lhe flrm ln perfecL
compeLlLlon
W or a compeLlLlve flrm marglnal revenue aL each
quanLlLy ls Lhe same as Lhe markeL prlce
W or Lhls reason marglnal revenue curve and
demand curve faclng flrm are Lhe same
A horlzonLal llne aL Lhe markeL prlce
Note: The scale of the price axes is the same for both but not the same for output.
W 1wo posslble shorL run proflL/loss scenarlos
W 1 ShorL run abnormal proflLs
W means LhaL Lhe flrms ln Lhe lndusLry ls
recelvlng revenue LhaL ls more Lhan enough Lo
pay for lLs LoLal cosLs lncludlng Lhe
opporLunlLy cosLs
osslble shorL run proflL and loss slLuaLlons ln
perfecL compeLlLlon
;erage Cost (C) = C ;erage Re;enue (R) = P

The firm is making abnormal profit of P-C on each unit.

W ShorL run losses
W lndusLry flrms are noL geLLlng enough revenue Lo
pay for Lhelr LoLal cosLs
C > R
The firm is making a loss of C P on each unit.
W ow wlll oLher flrms reacL when lndusLry flrms
make shorL run abnormal proflLs or shorL run
losses?
W JhaL wlll Lhe equlllbrlum polnL be ln Lhe long
run?
W 1wo scenarlos
W 1 ShorL run abnormal proflLs Lo long run normal
proflLs
W ShorL run losses Lo long run normal proflLs
1he movemenL from shorL run Lo long run ln
perfecL compeLlLlon
W 1 ShorL run abnormal proflLs Lo long run normal
proflLs
W AssumpLlons Lhere ls perfecL knowledge and no
barrlers Lo enLry
W lrms ouLslde Lhe lndusLry wlll sLarL Lo produce
also Lo Lake advanLage of Lhe abnormal proflLs
W As Lhe number of flrms become larger Lhe
lndusLry supply curve wlll sLarL Lo shlfL Lo Lhe
rlghL
W ndusLry prlce falls and Lhe demand curves of
flrms wlll shlfL downwards
W Abnormal proflLs wlll dlsappear
The firm is making a normal profit on each unit, P1=C1.
No abnormal profits to be made to attract new firms so the
industry is in a long run equilibrium situation.
The firm is satisfied because it is now co;ering all of their costs.
The firm is now making a normal profit on each unit, P1=C1.
No abnormal profits to be made to attract new firms so the
industry is in a long run equilibrium situation.
The firm is satisfied because it is now co;ering all of their costs.
W ShorL run losses Lo long run normal proflLs
W AssumpLlons no barrlers Lo exlL
W 8ecause of losses flrms sLarL Lo leave Lhe
lndusLry
W As Lhe number of flrms become larger Lhe
lndusLry supply curve wlll sLarL Lo shlfL Lo Lhe lefL
W ndusLry prlce rlses and Lhe demand curves of
flrms wlll shlfL upwards
W osses wlll dlsappear
W n Lhe long run flrms ln perfecL compeLlLlon
wlll make normal proflLs
W ShorL run abnormal proflLs or shorL run losses
wlll evenLually lead Lo long run normal proflLs
due Lo flrms enLerlng or leavlng Lhe lndusLry
ong run equilibrium in perfect competition.
C = R, profit is maximized by producing at quantity q.
The firm is now making a normal profit on each unit, P=C.
This situation will continue until there is a change in the
industry demand cur;e or in the costs that the firms face .