Institute of Business Administration

Jahangirnagar University

WMBA Program, Spring -2017

A Report on Perfectly Competitive Market

Course Title: Managerial Economics

Course Code: BUS 504

Submitted To:

Dr.K.M Zahidul Islam

Associate Professor

IBA-JU

Submitted By

SL NAME ID
1 Sayed Muztaba Ali 201602034
2 Rashedul Hasan Khan Pathan 201602048
3 Kamrul Hasan 201602072
4 Md. Saddam Hossain 201602037
5 Rubel Howlader 201602071

Date of Submission: 22 April, 2017

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 Table of Contents

No of chapter Name of Chapter Page

Chap-1 Introduction 1
1.1 Introduction
1.2 Rationality of the Report
1.3 Objectives of the Report
Chap-2 Market 2-4
2.1 Definition of Market
2.2 Definitions and Features of Different Markets

Chap-3 Perfect Competition Market 5-14

3.1 Definition of Perfectly Competitive Market

3.2 Characteristics of Perfectly Competitive Market

3.3 Different Influencing Factors of Perfectly

Competitive Market For Firms

3.4 Short run profit Maximization in perfect competition

3.5 Shut-down price, break-even price

3.6 Long run profit Maximization in perfect competition

3.7 Managerial Decision in Perfect Competition

Chap-4 Conclusion 15
4.1 Perception and Finding From the report
4.2 Conclusion
Bibliography

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 Chapter-1

Introduction

1.1 Introduction

Economics is the study of allocating resources among alternative uses to satisfy human
wants. Managerial Economics is one of the latest additions in Economics. Managerial
economics helps a manager to take different managerial decisions. In Managerial
Economics course market is a crucial part of industry decision making. In this free trade
era market determines its own features and way to go. For this perfect competition is
more describable than any other market. In our report, we basically describe why prefect
competition is important and what are the firms and consumers condition in a perfect
competition market.

1.2 Rationality of the Report

To complete Managerial course study and understand the subject matter of the course, a
report is a vital part for the pupils. By preparing this report, we will be able to apply
different method and rules of Managerial Economics in real life and also in the industry
management.

1.3 Objective of the Report

Perfect competition market is the vital part of market analysis. To understand and detect
the goods of perfect competition and the trend of perfect competition market, this report
will help us. This report will help us to make a clear understanding about the perfect
competition market and what will be the decision of industry in different condition.

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 Chapter-2

Market

2.1 Definition of Market

A market is any place where the sellers of a particular good or service can meet with the
buyers of that goods and service where there is a potential for a transaction to take place. The
buyers must have something they can offer in exchange for there to be a potential transaction.
There are two main types of markets- markets for goods and services and markets for the
factors of production. Markets can be classified as perfectly competitive, imperfectly
competitive, monopolies, and so on, depending on their features.

2.2 Definitions and Features of Different Markets

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Monopoly
A monopoly is a situation in which a single company or group owns all or nearly all of the
market for a given type of product or service. By definition, monopoly is characterized by an
absence of competition, which often results in high prices and inferior products.

According to a strict academic definition, a monopoly is a market containing a single firm. In

such instances where a single firm holds monopoly power, the company will typically be
forced to diverse its assets. Antimonopoly regulation protects free markets from being
dominated by a single entity.

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Monopolistic Competition
When there are many sellers and buyers and each firms in the industry produces and sells a
slightly differentiated products is called monopolistic market. Characterizes an industry in
which many firms offer products or services that are similar, but not perfect substitutes.
Barriers to entry and exit in the industry are low, and the decisions of any one firm do not
directly affect those of its competitors.

OLIGOPOLY

Market situation between, and much more common than, perfect competition (having
many suppliers) and monopoly (having only one supplier). In monopolistic
marketers, independent suppliers (few in numbers and not necessarily acting in collusion) can
effectively control the supply, and thus the price, thereby creating a sellers market.
They offer largely similar products, differentiated mainly by heavy advertising and
promotional, expenditure, and can anticipate the effect of one another's marketing strategies.

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 Chapter-3
Perfectly Competitive Market

3.1 Definition of Perfectly Competitive Market

When there are numerous buyers and sellers in the markets of an identical products and the
price of the product is determined by market is called perfect competition. Perfectly
Competitive Market is a market structure in which the following five criteria are met: 1)
All firms sell an identical product; 2) All firms are price takers - they cannot control
the market price of their product; 3) All firms have a relatively small market share; 4) Buyers
have complete information about the product being sold and the prices charged by each firm;
and 5) The industry is characterized by freedom of entry and exit. Perfect competition is
sometimes referred to as "pure competition".

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3.2 Characteristics of Perfectly Competitive Market

In order to attain perfect competition, several factors need to be met. The following list
outlines some of the main factors:

1. Knowledge is available to all buyers and sellers, and no individual has control over
the prices.
2. Buyers and sellers have no barriers to enter or leave the market.
3. Buyers and sellers want to maximize profit.
4. There are too many sellers and buyers to take control of the market.
5. All goods are homogeneous.
6. The government does not get involved.
7. There are no costs associated with transportation.

3.3 Different Influencing Factors of Perfectly Competitive Market for Firms

Fixed costs are costs that are independent of output. These remain constant throughout the
relevant range and are usually considered sunk for the relevant range (not relevant to output
decisions). Fixed costs often include rent, buildings, machinery, etc.

Variable costs are costs that vary with output. Generally variable costs increase at a constant
rate relative to labor and capital. Variable costs may include wages, utilities, materials used in
production, etc.

Total Fixed Cost (TFC):

Total amount paid for fixed input. Total fixed cost does not vary with output.

Total Variable Cost (TVC):

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Total amount paid for variable input. Total variable cost increases with increase in output.
Cost does not vary with output.

Total Cost (TC):

Total cost (TC) describes the total economic cost of production and is made up of variable
costs, which vary according to the quantity of a good produced and include inputs such as
labor and raw materials, plus fixed costs, which are independent of the quantity of a good
produced and include inputs (capital) that cannot be varied in the short term, such as
buildings and machinery.

TC=TVC+TFC

Total cost in economics includes the total opportunity cost of each factor of production as
part of its fixed or variable costs.

The total cost curve, if non-linear, can represent increasing and diminishing marginal returns.

Average total cost (ATC):

Total cost divided by the number of units of output.

ATC= TC/Q
= TVC+TFC/Q
= AVC+ATC

Average variable cost (AVC) :

Total variable cost divided by the number of units of output.

AVC= TVC/Q

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Marginal cost (MC):
The increase in total cost that result from producing one more unit of output. Marginal costs
reflect changes in variable costs.

Short-run Marginal Cost:

Short-run Marginal Cost is defined as the change in either total variable cost or total cost per
unit change in output.
SMC= ∆TVC/∆
= ∆TC/Q

Total revenue (TR):

The total amount that a firm takes in from the sale of its product: the price per unit times the
quantity of output the firm decides to produce (P x q

Marginal revenue (MR):

The additional revenue that a firm takes in when it increases output by one additional unit. In
perfect competition, P = MR.

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3.4 Short run profit Maximization in perfect competition
Short run:
The period of time for which two conditions hold: the firm is operating under a fixed scale
(fixed factor) of production and firms can neither enter nor exit an industry.
In the short run a firm can go three types of condition-
• Make abnormal profit
• Make normal profit
• Make losses.

Profit-Maximizing Level of Output

• What happens to profit in response to a change in output is determined by marginal
revenue (MR) and marginal cost (MC).

• A firm maximizes profit when MC = MR

• When profit, r =TR-TC is highest

A perfectly competitive firm will choose to produce an output where

1. MC = MR = P
2. MC curve cuts MR from below.
Mc Curve below MR means at such points Marginal Cost <> MR, then it means we are
incurring more costs then the revenue earned or profit is negative as ∆Π /∆q = ∆R/∆q – ∆C
/∆q i.e. change in profit = MR- MC)

1. Super Normal Profit

In short run, we have fixed as well as variable factors of production. In short run, a firm
maximizes its profit by choosing an output at which MC=MR=price.
The profit is measured by the difference in AC and AR and competing the rectangle. The
Profit earned is super normal profit in this case.

 E is the equilibrium situation in perfect competition.

 At E, MC= MR.A firm will produce its output till point E only because it maximizes
its profit.

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  AR=MR=P. (AR-AC) tells the average profit( profit for a unit) and
 to know total profit we have to multiply average profit with the number of units
sold(q). So, EACD is the profit that a firm will earn in short run.

2. Loss in Short Run

Not all firms make supernormal profits in the short run. Their profits depend on the position
of their short run cost curves. Some firms may be experiencing Losses because their
average costs exceed the current market price. Other firms may be making normal profits
where total revenue equals total cost (i.e. they are at the break-even output). In the diagram
below, the firm shown has high costs such that the market price is below the average cost
curve. At the profit maximizing level of output, the firm is making an economic loss.

 E is the equilibrium point. At this point MR= MC.

 Drawing a straight line from E to AC curve gives us the cost of the product.
 Here, AC >AR(or price). So, the firm is incurring losses.
 A firm should shut down its production if it is incurring losses. Here AQ1 is the cost
to the firm and EQ1 is the price of the product.

3. Normal Profit in short runs.

In short run, some firms may be making normal profits where total revenue equals
total cost (i.e. they are at the break-even output). In the diagram below, at equilibrium,
the firm has same costs such that the market price is equal to the average cost curve.
At the profit maximizing level of output, the firm is making a normal profit.

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Profit-maximizing level of output and price

A PCM firms are trying to maximize their profits in either the short or long-term and will
produce the quantity at which MC = MR. Because the firm is a price-taker, the price is set by
the market forces of supply and demand. There are three possible outcomes for the PCM firm
in the short-run. If the ATC curve intersects the MR curve at its lowest point, the firm will
break even or earn a normal economic profit as shown below in the first diagram. If the
lowest point of the ATC curve lies below the MR curve, the PCM firm will earn an
"abnormal profit." The yellow box in the second diagram represents the value of the
abnormal profit. Finally, if the lowest point of the ATC curve is above the MR curve, the
PCM firm will make a loss, represented by the pink box in the third diagram.

Short-run abnormal profits/losses

In the short-run, it is possible for a PCM firm to earn either an abnormal profit or loss. Let's
consider the case of earning an abnormal profit first. As mentioned in the previous section,
this occurs when the minimum point of the ATC curve lies below the MR curve. Assuming
perfect information, firms not already on the market will notice that the aforementioned firm
is earning an abnormal profit. Eager to get in on the action, some of these firms will enter the
market, especially since there are no barriers to entry. This subsequent increase in supply
causes the price to fall. New firms will continue entering the market and the price will
continue to fall until the first firm earns a normal economic profit once again. Now let's turn
to a PCM firm earning a loss. As mentioned in the previous section, a firm makes a loss when
the minimum value of the ATC curve lies above the MR curve. This may occur if too many
firms have entered the market. Over time, some firms will leave the market. This decrease in
the supply of the good will cause its price to increase. Firms that are able to "ride out the
storm" will find that they are no longer earning a loss, but a normal economic profit.

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3.5 Shut-down price, break-even price

A company has broken even when its total sales or revenues equal its total expenses. When a
company breaks even they was no profit that has been made, nor have any losses been
incurred. A firm's shut down price is when its average variable cost curve is above the
marginal revenue curve. When this is true, it is only a matter of time before the firm must
leave the market. When firms leave a market, the supply decreases, raising the profits of the
firms who stay in the market.

3.6 Long run profit Maximization in perfect competition

In the long-run a PCM firm will earn a normal economic profit. It cannot earn an abnormal
profit in the long-run because firms will enter the market and the subsequent increase in
supply will cause the price of the good to fall. Conversely, the firm cannot earn a loss
(provided it can cover its fixed costs) in the long-run because firms will leave the market and
the subsequent decrease in supply will cause the price of the good to increase.

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Efficiency in perfect competition

5 reasons why Perfect Competition is efficient:

1. Allocated Efficiency: This is because P = MC.

2. Productive Efficiency: Firms produce where MC=ATC.

3. X Efficient: Competition between firms will act as a spur to increase efficiency.

4. Resources will not be wasted through advertising because products are homogenous.

5. Normal profit means consumers are getting the lowest price. This also leads to greater
equality in society.

3.7 Managerial Decision in Perfect Competition

General Rules for Implementation of the Profit-Maximizing Output Decision

At first a manager has to check out two things

 Produce as long as the market price is greater than or equal to minimum average
variable cost’s> AVC. Shut down otherwise
 Produce the output at which market price equals marginal cost : P=SMC

 Step 1: Forecast product price

A manager must obtain a forecast of the price at which the completed can be sold.

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  Step 2: Estimate AVC & SMC
AVC  a  bQ  cQ 2

•
• Step 3: Check shutdown rule
• If P  AVCmin, produce
• If P < AVCmin, shut down
• To find AVCmin, substitute Qmin into AVC equation
AVCmin  a  bQmin  cQmin
2

Step 4: If P  AVCmin, find output where P = SMC

• Set forecasted price equal to estimated marginal cost & solve for Q*
P  a  2bQ*  3cQ* 2

• Step 5: Compute profit or loss

• Profit = TR - TC
 P  Q*  AVC  Q*  TFC
 ( P  AVC )Q*  TFC
• If P < AVCmin, firm shuts down & profit is -TFC

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 Chapter-4

Conclusion

4.1 Perception and Finding From the report

In this report, we use the theoretical graphical and also the mathematical issues to illustrate
the perfect competition market .By preparing this report now we know-

 The definition of Market and its different types.

 The definition of Perfect competition market and its characteristics
 Different types cost and revenue
 Profit maximization of perfect competition
 The shut-down point of industry or firms in perfect competition.

4.2 Conclusion

Actually perfect competition market is the market of daily necessary products. In this market
a firm can make abnormal profit, normal profit and losses in the short run and on the other
hand the firm can make normal profit in the long run. Because there is no entry and exit
barrier of buyers and sellers in the perfect competition market. Moreover, the buyers and
sellers make the market price over bargain. In the conclusion, by preparing this report we are
now able how to apply the different rules of perfect competition and make managerial
decisions.

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 Bibliography

1. Managerial Economics Concepts and Applications by Christopher R. Thomas,

S. Charles Maurice, Sumit Sarkar
2. Managerial Economics, H Craig Petersen & W. Cris Lewis,4th edition
3. www.investopedia.com
4. www.economicsonline.co.uk
5. https://en.wikipedia.org

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