Chapter

PERFECT COMPETITION

1. Introduce the basics of market morphology and

identify the different market structures. 2. Examine the
nature of a perfectly competitive market. 3. Understand
market demand and firm's demand under perfect
competition. 4. Analyse the pricing and output decisions of
a perfectly competitive firm in the short
run and long
run.
Chapter Objectives

INTRODUC
TION
By now
you have unde the
domains of different
Now you should also
unde upon better
understand Dean?
What are its ver
 have understood every aspect of demand, production and cost; you have
also explored into
ulfferent objectives of a business firm, be it profit maximisation or
revenue maximisation. d also understand the basics of a market, as
success or failure of any business is dependent derstanding of market
morphology, First of all let us see what does the word "market”
e its very dimensions? What is the degree of competition in a market?
By what extent oduct of a particular firm be different from those of its
rivals? Is there any need for
What is profit maximising output? What is the price to be charged for a
unit of a product? mportant dimensions of a market that need to be
understood for effective management of
should the producto
advertisement?
What All these are
impos ay business
firm.
Marke
t is defined id
sellers; it refers
good (or service)
be at a
particular pl Internet.
Sellers
.

defined as the institutional relationship between buyers Market refers to

the interaction between
cfers to the interaction between buyers and sellers of sellers and buyers of a good
(or service) at a
e) at a mutually agreed upon price. Such interaction mutually agreed upon price:
ular place, or may be over telephone, or even through TS and buvers
may meet each other personally, or may not ever see each other, as in
utshell, a market may be a place, or a function, or
even a process.
umerce. In a
nutshell,

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MARKET MORPHOLOGY
Market Morphology
on-making like productive
Cable 10.1 Market Morphol
For the purpose of analysis and understanding economic dimensions
of decision-mak and pricing, markets may be characterised on the basis of the
parameters discusse
MUN

s discussed in this section,

Number of
firms
Examples
Nature of
product Homogeneous (undifferentiated)
Number of
buyers Very Large
Freedom of entry and exit Unrestricted
Type of
market Perfect competition
Very Large
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+ There can be a market in which
mall, whereas there can be ese are two extremes, whil
Differentiated
Nature of Competition This refers to the number, size and distribution of
sellers in any market. There can be a very large number of sellers exist and size
of an individual seller is very small another market with only one very large
player, without any competitor. These are two ey there can be various
combinations between these two levels.
Many
Unrestricted
Many
Monopolistic
competition
Few
Few
Restricted
Agricultural commodities, shares unskilled labour Retail stores, detergents Cars, computers,
universities Indian Railways, Microsoft Indian defence industry
Undifferentiated or differentiated Unique
Oligopoly
Many
Restricted
Single
Monopoly
Single
Not applicable

U
Undifferentiated or differentiated
Monopsony Many
Nature of Product This refers to whether the product is homogeneous or
differentiated (even if slightly). The marker face may have sellers producing
(and selling) the same products which are almost identical. Typial
examples may be vegetables, minerals, precious metals and jewels. Then there
can be a market wit large number of sellers selling similar yet somewhat
different products like cosmetics, medicines a banking. As is obvious, decisions
related to price, output, etc., in each such market would be differen for these
situations.
In this chapter, we would introduce the very first type of market, namely perfect
competition, wherea about other forms are discussed in subsequent chapters.
PERFECT COMPETITION
Number and Size of Buyers
We know that any market has two players, a buyer and a seller. As we can
categorise markets on of number and size of sellers, so also can be done on the basis of
number and size of buyers. In buyers is very large but the size of individual buyer is
small, the market will be evenly bala, buyers and sellers. However, when number of
buyers is small and their size is large, the mai by buyers' preferences.
Among the various market forms introduced in Table 10.1, perfect competition is
the most basic. 1 appears to be theoretical and hypothetical, but at the same
time it deserves a discussion here because It is the most ideal form of market.
Its understanding facilitates the comprehension of all other forms ol markets.
Before a discussion on demand and supply curves of perfectly competitive firms and their
wac or equilibrium output and price in the short run and long run, let us see the
main characteristics of perfect competition.
large, the market is driven
Features of Perfect Competition
nce of Large Number of Buyers and Sellers
Freedom to Enter into or Exit from the Market Some markets may be very
difficult to enter, there may be financial restrictions, legal technological constraints on entry.
At the other extremne, entering a market may be
y such restriction. In agricultural and allied industries, a person or a group of perso a motive of
making profits through farming, without any legal, financial or technon In such situation, a
perfect competition or a monopolistic competition form of man would discuss in subsequent
chapters. Remember where entry is difficult exit is also di
Table 10.1 summarises the different forms of market on the basis of parameters Trithis book, we
would focus on perfect competition, monopoly, monopsony, mom
ons, legal compulsions and may be very easy, without p of persons may enter 176 T
technological constrains.
Presence of Large There are many sellers (or sus market, to affect the market pro large that
any particular fim, market price by selling
The market is also classico to the entire market, that the
y sellers (or suppliers) in the market, each being too small in size, relative to the
overall
the market price through a change in its own supply. The number of firms also is
so
ticular firm, being so negligible with respect to the market, can, in no way, affect the
by selling a little more or a little less of the product.
so classified by a large number of buyers. Besides, buyers are so small in comparison why
that they cannot exert any influence on the market price.
et arises, which we ISO difficult
Homogeneo
mogeneous Product
and oligopoly.
rameters discussed above. sony, monopolistic comper
the products sold by perfect
product of one fimm from
homogeneous produ difficult for any con
perfectly competitive firms are so identical, that buyers are not able to distinguish
um from that of another firm. In other words, perfectly competitive fimms sell a Product. Let us
explain with an example: Consider unbranded spices, it would be very y consumer to differentiate
between spies
en soices sold across the market. This is what we refer
304
Managerial Economics
Perfect Competition
305
various sellers within
e factors, each factor will charge a single price in the market, just as the price of
to as product homogeneity; this makes the buyers totally indifferent towards vari to
purchase of the product, because products of all the firms are perfect substitutes
substitutes of cach other.
corices charged by the factors, cac the commodity being sold,

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Governmental Intervention
into the industry in the This implies that the mic
Freedom of Entry and Exit In a perfectly competitive market, there is no
barrier to the entry of new firms into ti run; a new finn can enter the industry
with even a very small investment. This impl is open to competition from
new suppliers. This, as we shall sce subsequently, would at profits
made by existing firms in the industry. Similarly, any firm in the industry has the
out in the long run. In fact, firms incurring losses do leave the industry in
the long run
teresting aspect of perfect competition is the complete absence of governmental
vernment neither imposes taxes on the product, nor provides subsidies. At the
same no legal restriction on entry into or exit from the industry.
Another very interesting aspe intervention. Government time, there is no legal restricti
US W

industry has the freedom to ne

Firm is a Price Taker Many scholars assert that the characteristic
Perfect Knowledge Producers and buyers have perfect knowledge about the
market. All firms, whether existing reel entrants, know about the production
functions, technology(s), input prices and the prevailing met price. Also, all
buyers know the quality of the product and the price charged by the firms,
and they b: no preference for any particular firm, as the products sold by
all the firms are homogeneous. Thus, the is complete information or
perfect knowledge in the market.
Scholars assert that the characteristic of a firm being a price taker 13 the most important of all
ristics of this market. A perfectly competitive firm is so small in comparison to the entire
that it has no influence, whatsoever, on market conditions. Hence, an
individuai firm, which is Wira drop in the ocean, ends up accepting the prevalent
market price, which is determined by the forces of demand and supply. The market
equilibrium explained in Chapter 4 is actually attained only under perfect competition
because in this market form the forces of demand and supply are unaffected by any
determinant other than the price of the product.
Reality
Bites
Perfectly Elastic Demand Curve The demnand curve of a perfectly competitive
firm is perfectly elastic. If a particular fim actie charge a price higher than the
existing market price, its demand will be reduced to zero. This buvers have perfect
knowledge about the product and the prevailing market price and my about a particular
firm, if one fire increases the price, buyers would promptly move any and shift over to its rival firms.
 On the other hand, if a firm tries to gain advantage o". by lowering the price, its
demand would increase to infinity. Either of these would i elastic demand curve. Refer to
Figure 10.2 for the demand curve of a perfectly comp
el price and they are indiffere
y move away from this
ntage of increased deras of these would lead to a perfas "a perfectly competitive firm.
A Case Study in Perfect Competition: The U.S. Bicycle Industry U.S. bicycle industry
has been cited as a classic state of perfect competition, feat.nng component "ianuracturers in
haste to get the latest designs and functionality to market in time and Dicycle suppliers uggling to
design bicycle products that have more value than the competition. Retailers are anxious out how
much to commit for and what to bring to market, whether to become a concept store or hale
independently, and which suppliers to do business with. Alongside, it has also been observed
och buyer or seller in this industry has a negligible impact on the market price and that everybody me
laker, earning the bare minimum profit necessary to stay in business.
mww.jaytownley.com/the-bicycle-industry-competition, based on blog summas oy ay Towney on Sunday,
2006-07-16, accessed on 21/11/2007.
Source: http://www.jaytownley
Aperteciyesstc demand curve is a honzontal straight line.
There is another interesting dimension to this phenomenon. Any increase in p actually invoke
a large substitution effect away from this firm to the other mms
erheet substitutes, and buyers have no preference for the product of one par both these r02030, Do
periectly competitive firme perceives any motivation to che
DEMAND AND
WD AND REVENUE OF A FIRM
use in price by one firm wice her firms because the proce one particular firm. Become
lon to charge a higher or
price for its product
Let us now understand the co Secall that following the as Soms in a competitive ma spends
on quantity only.
THINK Out Of Box What is the value ofe, in case of perfectly elastic demar What is
the sponding value of MR?
and the concepts of revenue and cost of a firm under perfect competition. You would
8 the assumption of rationality, all firms would aim at maximisation of protit. Since
hive market are price takers, they can only adjust quantity at a fixed price. Hence, TR "y
only. Following the concept of MR, we have

UTRPO Marginal Revenue (MR) = -

Perfect Mobility of Factors of Production
re is gericci bity D iscossos production, te, resources are lo othet and car. A4 pony katy bluangt in factor
payments. Since
There is periect sobre
aces are free to move
Move from or in
9. Since there is perfer!
306
Managerial Economics

REMEMBER
Perfect Competition
307
Total Revenue (TR) is the multiplicative product of the price and the quantit
TR = P.Q
om Figure 10.1, the profit curve begins from the negative axis, implying that in
tout less than OQ, the firm actually incurs losses. This is because the total cost
ut less than 0Q, is more than the revenue earned by selling it. To produce output ulú
incurs losses equal to zero; this corresponds to the point A, where the total revenue
ntersect each other for the first time from the left. The firm starts earning profits noutout
greater than OQ, and earns maximum profit at output OQ*. Beyond OQ*, stion will lead to
reduction in profits. At point B, the TR and TC curves intersect again; ut where the falling
profit level is equal to zero, corresponding to output 0Q2. Thus, any
As you can see from Figure order to produce an output less the of producing any output less than
001, the firm actually in and total cost curves intersect each when it produces an output great
any extra production will be this is the point where the fall
[P is assumed to be given (constant)].
REMEMBER
Marginal Revenue (MR) is the additional revenue that a firm makes by selling one ex
selling one extra unit of output
national producer must produce an output OQ*, in order to ma
Since firms are price takers and can supply as much as they Under perfect
competition, AR=MR =P
... the existing price in the market, we may say:
AR = MR =P _ REMEMBER
Calculus Corner In all market forms, the principal objective of the firm is to maximise
profits. In other words, its objective is:
Max II = R(Q)-C(Q)
Average Revenue (AR) is the total revenue eamed divided by the total quantity produced. AR
=P
In order to determine just how much each firm wants to sell, or how much each firm
is willing a offer at the prevailing market price, we have to use the concept of costs. In Figure
10.1, TR is the love Revenue curve, sloping upward; TC is the Total Cost curve in the short
run, drawn on the basis of us law of variable proportions. Profit is derived as the
difference between Total Revenue and 1
TC
The first order condition of profit maximisation is given as:
di dR(Q) dC(Q) dQ dQdQ
= 0 MR - MC = 0
MR = MC The second order condition of profit maximisation is given as:
MR MMC
<0
dQdQ → Slope of MR curve <Slope of MC curve summarise, the profit maximising
conditions are given as:
sary Condition: Marginal Revenue is equal to Marginal Cost. Lancient Condition: MC curve
cuts MR curve from below.
TR

- Profit
Revenue, Cost, Profit
Let us explain the concept
am the concept of profit maximisation with a numerical example.
. calculate the output
Quantity
Given the following equ that maximises prohit at Solution: The profit maximising
following equations: TR = 48Q-Q and TC = 12 + 16Q- ises profit and the amount of maximum
profit.
Maximum
Profit
Ximising output can be determined from the conditions of prodit maximisation.

MR = = 48 - 20
Fig. 10.1 Prote, Revenue and Cost Curves o
U
Quantity

MC -
TC 16 + 660
308
Managerial Economics
Perfect Competition
309
Profit is maximised when
MR = MC: 48 - 2Q = 16+6Q
Q = 4 dn
=-8<0 dQ?
mpetitive firm, being a price tak afirm can sell all it wants at 1 a shape of the demand curve
even a slightly higher price. It is since it can sell as much as it w of a firm would increase
Average Revenue will be equ. the firm will be a straight bor
Second Order Condition:
eing a price taker, takes the equilibrium price from the market as given at P*
Since it wants at this price, it faces an infinitely elastic demand curve for its product.
Such and curve also implies that the firm can sell not even a single unit of its product at
er price. It is not worthwhile for the firm to offer any quantity at a lower price either,
much as it wants at the prevailing market price. This would imply that Total
Revenue Jd increase at a constant rate, i.e., Marginal Revenue would be constant. In
other words,
e will be equal to Marginal Revenue (refer to equation (2)). Hence, the demand
curve of be a straight horizontal line, showing perfect elasticity of demand, and
this infinitely elastic curve, drawn at market price, coincides with the AR and MR
curves.

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The equation for profit is: 11 = R(Q)-C(Q) = 48Q-Q-(12 + 16Q +30)
=-12 + 32Q-402 Substituting Q = 4 in this equation we get: 17 =-12 +
128 – 64 = 52
MARKET DEMAND CURVE AND FIRM'S DEMAND CURVE
THINK OUT OF Box If the demand curve of a perfectly competitive
firm is horizontal, why is the market demand curve downward sloping?
o
SHORT RUN EQUILIBRIUM
The market demand curve for the whole industry is a standard The market demand
curve for the industry is a standard outward sloping cune.
downward sloping curve, which shows alternative combinations of
price and output available to the buyers, such that an individual buya The demand
consta inintual firm is
is able to get the maximum amount of output at each existing price, at a
horizontal straight line
a given time. Definitely, the buyer would demand more of the product
at lower prices, and less at higher prices, other things remaining equal. The market
demand curve is the horizontal summation of individual demand curves. The
demand can for an individual firm is a horizontal straight line showing that the firm
can sell infinite volumica at the same price.
The market supply curve is upward sloping, giving various combinations of price and
op the maximum output any firm is willing to produce and supply at each specified price, at a
B Fins definitely are willing to sell larger quantities of output at higher prices, and on
lower prices, other things remaining constant. The market supply curve is the
horizontal s all the individual supply curves of the firms.
In the short run, an individual firm under perfect competition may
either earn supemormal profit, or normal profit, or can incur losses. This
depends on the positions of the short run cost curies. These three possibilities are
shown by the three short run equilibrium positions of a competitive firm. Let us
begin this section with the assumption that in each case, the point of market
equilibrium is attained by the intersection of market demand curve and market
supply curve, at point E. An individual fimm takes uc equilibrium price P* as given, and
faces an infinitely elastic demand curve given by P = AR = MR, as shown in
Figure 10.2.
"price and output; it shows upply at each specified price, at a given time.
nices, and lower quantities u une horizontal summation of
Case of Supernormal Profit
In Figure 102 market equilibrium is reached at the point of intersection of the man
market supply curves, le., at E, equilibrium output for the industry is given at :
on of the market demand and
Marginal Cost (MC) curve the firm maximises pronts also where MC cuts MR irom
INDUSTRY
Princ
FIRM
S Market
Supply

Pries
Price
won run a perfectly competitive firm can earn supernormal
In the shorten a perfectly compentive ats (When revenue exceeds cost). The Average Cost (AC) and
firmayeurs supemernal prefit.
Cost (MC) curves are the usual short run cost curves. As of normal pront, or can incur losses,
imises profits at the point where MR is equal to MC and depending on the sos
tons of the stort run
cast cances uts MR from below, the point of equilibrium of the Figure 10.3 is at point
E; output at this price So, by selling og* equilibrium output at "price P*, the total revenue
earned by
AC "ven by the rectangular area OP*E*
AR = MR ne AR curve, since TR = ARQ). To Big i s output, the total cost incurred by the
kiven by the rectangular area OADS
curve, since TC = AC.Q). Therefore, ned by the firm is given by the rectangu
. Quantity the superormal protit made " the short run, because the ruling
Fix. 10.3 Supernormal Prolit in the Short Run is greater than average cost.
P = AR - MR
fimm in Figure 10.3.1 is OQ. So, by sellin equilibrium price pe the firm is given by the
(area below the AR CU produce this output, firm is given by below the AC curve, si profit
earned by " Tegion APEB." by the firm in the sho
arket price p* is great

-
Fig, 10.2 Deriand Curves of Industry and Firm
Quantity
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Managerial Economics
Perfect Competition
311
Let us explain profit maximisation by a perfectly competitive firm with a nur
with a numerical example.
Funit is TC = 2400-20
level of output is given by the han the revenuc carned by selling o
iven by the rectangular area OABQ*. Thus, the total cost of producing OQ* is more
ned by selling OQ*. The amount of loss incurred by the firm is given by the area rm incurs loss
or subnormal profit in the short run because the a is more than the ruling market price.

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this output is more than
Total cost function of a competitive firm selling its product at 640 per unit is TC =
go+Q Find the profit maximising output and the value of maximum profit Solution:
TC = 2400-2002 + Q
MC = 240-40Q + 30 For profit maximisation MR = MC, when MC is rising,
Since this firm is in perfect competition P= MR = AR = 640
240 - 40Q +30° = 640 Solving for Q, we get: Q=-20/3 (rejected) and 20
(accepted)
u Case: Exit or Shut Down Point
You might be wondering losses in the short run
market conditions im
ht be wondering as to what a firm would do, if it incurs
if price is less than AVC, a perfectly the short run. Will it decide to withdraw from the
market
competitive firm shuts down operations. liately? No. It will actually prefer to wait and find out whether
conditions improve in the long run. If, however, it continues to make losses in the long run, firm
will ultimately have to leave the industry. So how does a fim decide on whether to continue
production in spite of incurring losses, or to shut down operations?
If the prevailing price in the market is more than the average variable cost (AVC)
of production, the firm would continue production. But if AVC exceeds AR, the firm would
shut down.
Let us elucidate the concept of shut down with a numerical example.

O
Second order condition:
dr
=- 800
dQ?
The equation for total profit is: N = R(Q)-C(Q) = 640Q-2400-200++ Substituting
Q = 20 in this equation, we get: 1 = 8,000
The Total Cost (TC) of a perfectly competitive firm is given as: TC = 1000 -
2000 - 200+ 20. Below what price of the product may the firm decide to shut
down its operations?
Case of Normal Profit
Solution:
Not all firms eam supemormal profits in the short run; some of them may also cam normal
(when revenue is equal to cost). As in the previous case, equilibrium of the firm is shown Figure
10.4, the output that maximises profit is OQ*. Total revenue earned by the frm by is the
rectangular area OP*EQ. Similarly, the total cost of producing 00* is also given by OpE0.
Profit is thereby nil, in other words, the firm makes normal profit, and actua? producing at uc
UICAK-even level of output. This situation occurs because the areas tangent to the average revenue
line.
· Profit is there to g*. Similarly in og*. Total reventorium of the firm
TC = 1000 + 2000-200° + 20
MC = 200 - 40Q +6Q, AVC = 200 - 200 + 20 The shut down point is where p =
minimum AVC. But profit maximisation requires that P = MC. Thus, by setting MC =
AVC, we get:
200 - 40Q+60° = 200 - 200 + 20°
40-20Q = 0, solving this equation we get Q=0.5.
tired of outpuer ads the firm of producing red by the
fir
mal profit, and actually ends up
average cost curve is
Price
MC
AC

Price
MCAC
osatuting Q = 5 in the MC equation, we get P = MC = 150. Substituting Q = 0 in the MC
quation, we get P= MC = 200. Thus, we can conclude that if price fails below 150 per unit,
m should shut down its operation. This is because if price is less than AVC, the firm is not en
able to cover the variable costs of production.
-
AR = MR
AR - MR
As long as the market all its variable costs and actually denotes the shut ac
as the market price is above the AVC of the firm, in spite of making losses, the firm will cover
* costs and will wait and hope to cover the fixed costs in the long run. Point.f in Figure 10.6
ves the shut down point, where price P* is equal to AVC. Any fall in market price blow p*
O" Quantity Fig. 10.4 Normal Profit in the Short Run
hill cause this firm shut down.
g* Quantity Fig. 10.5 Loss in the Short Run
THINK OUT OF Box
Case of Loss (or Subnormal Profit)
re 10.5, point E determines the equilibrium level of output OQ* to be produ we is given by the
rectangular area OPEQ* (as in the earlier cases) and the
In Figure 10.5, point E deter revenue is given by the recta
If a perfectly com losses would be eu
'perfectly competitive firm shuts down in the short run,
would be equal to fixed cost of production only. Derive.
produced by the firm. Tol The cost of producing !
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Managerial Economics
l'erfect Competition
313
INDUSTRY
FIRM
Price
MC AC
Price
REMEMBER
ompetitive firm's short run supply curve is a function of costs.
A perfectly competitive firm
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L
AVC
re 10.7 for any price less than P** (which corresponds to the
the supply curve coincides with the vertical axis p** the supply curve is the rising portion of MC curve,
In Figure 10.7 for any prie minimum of AVC), the supply curve co and above p**, the sur
shown as a bold line.
Supply curve of the firm is identical to the short run MC curve above the minimum point of the
AVC curve.
- AR = MR
OL

Quantity
2* Fig. 10.6 Subnormal Profits with Shut Down of Production
Quantity
THINK OUT OF Box Would a firm supply when price is equal to
AVC?
O
MARKET SUPPLY CURVE AND FIRM's SUPPLY CURVE
You have seen that the demand curve of the firm is its average revenue curve. Let us also see
how to derive the short run supply curve for a firm. As you have seen in the previous section,
the perfecus competitive firm produces above the minimum point of its AVC and discontinues
production is per falls short of minimum of AVC. This can be summed up with the following
conditions:
Now that an individual firm's supply curve in the short run has been derived, let
us move ahead to determine the supply curve of the industry, which is obtained
by the horizontal summation of the supply curves of all firms in the industry. Let
us assume for the sake of simplicity that the market comprises only two firms,
having identical MC curves. At each price, we can obtain the total supply in the
market by adding the quantities supplied by both the firms. This can be extended to n
firms, whereby the industry supply curve would be n*MC. Like the supply curve of an
individual firm, the industry supply curve is also upward sloping, since it is the summation of
all short run MC curves above their minimum AVC, which are positive.
Let us now sum up the short run equilibrium condition with a numerical example.
Condition 1: If Price < minimum AVC, then shut down. Condition 11: If Price 2 minimum AVC,
then choose any output that would maxim
We can derive the short run supply curve for an individual firm from these two como obvious that
if the price is any less than minimum AVC, the firm would not produce for output would be
equal to zero. In other words, for such price, the supply curve woul the vertical axis. For any
price above minimum AVC, the firin would choose an output satisfy the conditions of profit
maximisation. And, thus, the supply curve of the firm wou to the short run marginal cost curve
above the minimum point of the AVC curve.
ese two conditions. It is
oduce (or supply), i.e. curve would coincide with an output level that would
hrm would be identical
consider the following market demand and supply curves in a perfectly competitive industry
as 2.9=25 -0.5P and S: q = 10 + 1.0P. Now, consider a firm in this industry whose cost
function IS C = 25 - 2 + 40. Should this firm produce in the short run? If it produces, then in how
much quantity should it produce? Solution: arket equilibrium price is 25 -0.5
P= 10 + 1,0 P (D=5)
P = 10 and Q = 20
Price
The cost function of th For profit maximisation
SAC
AVC
po
P
.

The firm will produce

si function of the firm is C= 25 - 2q + 49*
MR = MC =P MC =-2 + 8g=P
q = 1/8 (P+2) will produce as long as the AR 2 AVC
TVC = -29 + 40° AVC =-2 +49
nimum. The firm would produce that quantity which is: P + 2) = 1/8 (10 + 2) = 1.5 units
Fig. 10.7 Supply Curve of Firm in Short Run
AVC is a linear functio | 9=1/8 (P+ 2) = 1/8 (10
Quantity
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Managerial Economics
Perfect Competition
315
TR = 10*1,5 = 15 TC = 25 - 2(1.5) + 4(1.5)2 TC = 31
Let us sum up the above discus condition of perfectly competitive fir
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The long run supply curve of the industry shows then
the above discussion and explain the profit maximising
ng Condition for long run equilibrium in
Fun in Figure 10.8. perfect competition is P = LAC = SAC = e of the industry
shows the phenomena of SWC = MR = AR exit of firms we have explained previously.
The point of min the long run is where each firm would be operating at the
minimum points of both its short
run average cost curves, thus, attaining full economies of scale. Point E, in the
figure nts the long run equilibrium point at which P = LAC = SAC = SMC = MR = AR.
There is a loss of 31 - 15 = 316. This is less than the total fixed cost of 325.
Therefo would produce 1.5 units and incur a loss of 16.
fore, the fim
entry and exit of firs
run and long run average cost curves
LONG RUN EQUILIBRIUM
represents the long n
PERFECT COMPETITION: EXISTENCE IN REAL WORLD
In the long run, perfectly competitive firms earn only normal profits. This is
due to the unrestricted entry into and exit of firms from the industry in the
long run. Let us explain this with two extreme possibilities: first, when
existing firms enjoy supernormal profits in the short run; and next, when the
existing firms incur losses in the short run. If some of the existing firms eam
supemormal profits, this attracts new firms to the industry to gain profits.
With the entry of new firms, the supply of the commodity in the marker
increases. Assuming no change in the demand side, this lowers the
price level. This process of adjustment continues till the price becomes equal to
the long run average cost (AR = AC = MR = MC). As such, supernormal profits of the
existing firms are squeezed until all the firms in the industry eam profit. In the long run,
perfectly competitive firms Alternatively, suppose firms are making losses in the
short run. I als eam only normal profits.
would force some of them to leave the industry in the long run,
may not be able to sustain losses for long. Their exit from the man causes a reduction in the supply
of the product and as a result the equilibrium price in the This process of adjustment continues
up to the point where the marginal firms no long. lie. till the price line becomes
tangential to the AC curve). Equilibrium occurs at a porno jangent to the long run
average cost and all the firms make normal profit in the long run competitive firms
earn only normal profits in the long run. From the above disc conclusively say that
the condition of profit maximising behaviour of firms in the 1005
P = MC = MR = LAC
w
um price in the industry rises.
no longer earn losses
urs at a point where price is al profit in the long run. Thus, perfect
ne above discussion, we may
Does perfect competition exist in the real world? Or is it just a myth
existing in the pages of textbooks? Let us explore.
You have read about the features of a perfectly competitive market.
These features are rarely found to exist together in any real market.
Consider product homogeneity, it is difficult to find a perfectly homogeneous
product; most real life products have some degree of differentiation.
Even with a product as simple as spices, producers may introduce
differentiation by variation in the brand name and packaging. Still we can find
some examples where most of the properties exist. Agricultural commodities
actually come closest to being homogeneous. Other examples may be the stock
market or petroleum products. Consider perfect knowledge. In spite of
exponential increase in consumer awareness in the mlemet era, perfect
information as a feature is not commonly found in any industry.
» a result, perfect competition is not a common phenomenon in the real world. Can we say it is a
omer? Because as such firms in this market do not compete with each other, they accept whatever
Prevails and adjust their supplies accordingly. An individual firm cannot even make
a negligible
" the market. Hence, one wonders whether there is any competition at all. spite of all
odds, if we take a brief stock of the different features, ural market that probably comes
closest to exhibiting Perfect competition is the most eficient
and ideal form of artet where 38 e features of perfect competition; it is characterised by
many
economic resource re put to productive oducers (farmers) who do not have the ability to
command tuc use only and marter zconomy prevaris. pnce of their products. There exists
knowledge (though not
y about the product and its price in the market; entry into and exit from the market is also
think of the share market as another example of perfect competition, 28 it comes close Icatures of
perfect competition. Even the bullion market can be taken as a case of perfect
one price prevails for precious metals like gold and silver. ve wondering as to why at
all we need to know about perfect competition, if it is rarely
e. In spite of its rarity in real life, perfect competition still finds relevance in economic
hy because it is the most efficient and ideal form of market which ensures that all "sources are out
to productive use. It will not be an exaggeration to say that market economy ense prevails only in
perfect competition.
petition. All of the developed countries strive towards of perfect competition in all markets,
wherever possible.
...(5)
it is the agricultural market that almost all the features of perfectco small producers
(farmer selling price of their produ exactly perfect) about the easy. We can think of the
to fit all the features competition as one price P
SMC
Price

SAC FLAC
lound in real life. In sp theory, especially beca
AR = MR
LAC - SAC - SMC = MR = AR
in its true sense P
Teaching the stage of per
Fig 10.8 Long Run Equilibrium
Output