CHAPTER 10.

Perfectly
Competitive Markets

SEM II
QUESTIONS

• WHAT IS A CORNER
SOLUTION? HOW DOES IT
OPTIMIZE THE PRODUCER?
Offshoring refers to the outsourcing of
services such as software programming,
accounting, or call center operations from
firms overseas, instead of having the firm’s
own employees provide those services.

How does offshoring lead to lower costs for

the producer?
WHY DO WE HAVE
DIMINISHING MARGINAL
RETURNS TO LABOR IN THE
SHORT RUN?
HOW DOES GREATER FACTOR
INPUT SUBSTUTUTION LEAD
TO WAGE INEQUALITY?
PERFECTLY COMPETITIVE MARKETS
• https://www.youtube.com/watch?v=h0a8t03TUqo
• LARGE NUMBER OF BUYERS AND
SELLERS

FIRMS ARE PRICE TAKERS

• The industry is fragmented.
• Firms produce undifferentiated products.
• Consumers have perfect information about prices all sellers
in the market charge.

• The industry is characterized by equal access to resources.

• The first characteristic—the market is fragmented—implies
that sellers and buyers act as price takers
• Equal access to resources—implies that the industry is characteriz
by free entry.
REAL LIFE EXAMPLE
• https://www.youtube.com/watch?v=6RuoRBnnlOY&t=523s
CATFISH FARMING
• In 2018, U.S. catfish farmers had sales of over $360 million
and employed more than 10,000 people.

• Accounts for about half of U.S. “aquacultural” production.

• In the state of Mississippi : 201 farms raising food-size catfish

in 2013; in the US: over 600 catfish farms in 2013.

The catfish produced by any one farm are, in the eyes of the
ultimate consumers, a perfect substitute for the catfish
produced by any other farm.
• Sellers and buyers are well aware of prevailing prices,
and information about prices is easy to get. For
example, the U.S. Department of Agriculture publishes
monthly reports on catfish
prices.

• The technology of catfish farming is well understood

and easily accessible, and the financial requirements to
enter the industry are not onerous.
Krishna Rajendra Market ,Bangalore
 WHAT WE KNOW about REVENUE?
•TOTAL REVENUE : total income earned from
selling one unit of output .
TR = P x Q
MR = ∆TR/ ∆Q
AR = TR/Q = PXQ/Q = Price of the
product

PROFIT = TOTAL REVENUE – TOTAL

COSTS
PROFIT = TOTAL REVENUE – TOTAL
COSTS
Items
REVENUE 100000
SUPPLIES AND HIRED 50000
LABOR
BEST OUTSIDE 20000
ECONOMIC
OPPORTUNITY
ECONOMIC PROFIT =
ACCOUNTING PROFIT =
 APPLICATION OF ECONOMIC PROFIT
• ECONOMIC VALUE ADDED : ACCOUNTING
PROFIT – MIN RETURN ON INVESTED
CAPITAL

• HIGH EVA : delivered a return on invested

capital that exceeds the minimum return
NEGATIVE EVA: failed to deliver that return.
LOW EVA PRICING
STRATEGY
Strategic choice by Amazon’s management to attract
consumers through low prices, one-stop online
shopping for an enormous variety of merchandise, and
the promise of fast delivery through Amazon Prime
A B
PROFIT MAXIMISATION FOR A
PERFECTLY COMPETITIVE FIRM
•P=MC
•MC cuts MR (P) from below
• https://www.youtube.com/watch?v=JP2cc1stRN4
In PERFECT COMPETITITION

• P =MR
MR is equal to the consumer demand which
is horizontal to the x axis.

How do we determine profit maximisation in

the perfectly competitive firm?
• DEMAND CONSUMERS
PRICE

• SUPPLY SUPPLIERS
COST
SHORT RUN COSTS
STC =
SFC +NSFC+TVC, Q>0
SFC, Q =0
TVC: materials costs and the costs of certain kinds of labor
(e.g., factory labor).Are zero if the firm produces zero
output and thus are examples of nonsunk costs.

SFC: cost of leasing, investment

NSFC: Cost of heating the greenhouses in case
of rose production.
SHORT RUN SUPPLY
CURVE
Shows how the firm’s profit-maximizing output decision
changes as the market price changes, assuming that the
firm cannot adjust all of its inputs (e.g., quantity of capital
or land).

 PROFIT MAXIMISING OUTPUT

 SHUT DOWN POINT FOR A PRODUCER

• $0.25 per rose : 50,000 roses per month (point A
in Figure ).

• $0.30: 55000 roses per month

• $0.35 : 60000 roses per month
• P = SMC
• A, B, and C are all on the firm’s short-run supply
curve.
SHUT DOWN POINT for a PC FIRM
• when it is making losses

• When price is less than AVERAGE

VARIABLE cost

• No incentive to produce
• $0.05 : 25000 roses

• Less than AVC

• LOSS : TFC plus 25,000 (AVC − 0.05)

• P <AVC (shutdown point for the firm)

• A profit-maximizing price-taking firm, if it produces
positive output, produces where P = SMC and SMC
slopes upward.
• A profit-maximizing price-taking firm never produces
where P < AVC.

• Ps : firm’s shutdown price, the point of zero output

Shutdown price: The price below which a firm
supplies zero output in the short run.

If the market price is greater than PS, the firm will

produce a positive amount of
output, and its short-run supply curve will
coincide with its short-run marginal
cost curve.
PROFIT ANS LOSS FOR A PRICE TAKING
FIRM
• P > Average costs : Positive economic profit

• P < Average costs : Negative economic

profit

• P = MC : zero economic profit

• WHAT HAPPENS at $0.18?

• Firm still produces by incurring losses but at least can

recover some of the variable costs.

• Firms might operate during periods in which they earn

negative economic profit.
SUNK AND NON SUNK COSTS with zero
output
• Offshore oil platform : fixed number of wells that may
operate at a time.

• The company cannot drill a new well if all allocated

wells are producing at an economic rate (as determined
by the government).

• Once a well begins to operate below that rate, the oil

company can drill a new well for the platform, if it has
the resources and decides that it would be profitable to
do so
COST STRUCTURE
• VARIABLE COSTS: drilling supplies, such as drill bits,
and fuel.
• FIXED COSTS: maintenance, food, medical care,
insurance, and the wages of its crew.

• The crew costs are fixed because a contractor typically

commits to hiring a crew for a particular period of time,
and thus its labor cost does not vary with the number of
wells drilled.
ZERO OUTPUT SCENARIO
• Hot Stacking: A “hot-stacked” rig is taken out of
service temporarily (perhaps for a few weeks)
but remains fully staffed and ready on short
notice to begin drilling again.
• NO variable costs, but all other costs continue to
be incurred.
• When a rig is hot-stacked, all fixed costs are
sunk.
• WARM STACKING : out of service for a
longer time.
COSTS : costs that are avoided by a hot
stacked rig, and it also avoids some
maintenance expenses and some labor costs
(since some workers may be laid off).
When a rig is warm-stacked, some fixed costs
are sunk, while others are nonsunk.
• COLD STACK: taken out of service for a significant
period of time.
• The rig’s crew is laid off.
• All fixed costs are avoided except for insurance.

• Insurance would thus be a sunk fixed cost, while all

other fixed costs (maintenance, food, medical
supplies, and crew costs) would be nonsunk.
RECESSION AND OIL DRILLING
• More uncertainty; the price of oil was expected to be
lower than it otherwise.

• Rig associated with that platform was cold-stacked.

• Labor costs for the rig were nonsunk in this case.

• If the company anticipated that one or more slots would
soon need to be drilled, it would have the contractor
warm stack or hot-stack the rig,
In the short run, a firm can incur significant sunk
or non -sunk costs
COVID LOCKDOWN : 21 DAYS
• WHAT HAPPENED TO RESTAURANTS ?

• ANY SUNK COSTS? ANY NON SUNK COST?

 P>ATC : economic
profit

 P <ATC : economic
losses

 P=ATC : break even

point