ECONDEV REVIEWER

CHAPTER 6: MARKET EQUILLIBRIUM AND THE PERFECT

COMPETITION MODEL

● Market Equilibrium - Quantity Demanded = Quantity Supplied

● Market - Collective activity of buyers and sellers for a particular product or
service
● Perfect Competition Model - The gold standard market (it is the best
among the market structures)
5 ASSUMPTIONS OF PERFECT COMPETITION MODEL
1. The market consists of many buyers
2. The market consists of many sellers
3. Firms that sell in the market are free to either enter or exit the market
4. The good sold by all sellers in the market is assumed to be
homogeneous
5. Buyers and sellers in the market are assumed to have perfect
information
● Buyers are considered as PRICE TAKERS
● The buying decisions of buyers has no impact on price
● The production decisions of sellers has no impact on price
● PERFECT INFORMATION - price, capabilities, and resources
● Compositions of production costs in the long run
● Long-run time frame for a producer to have enough time to impliment any
changes to its processes
● In theory, in the long run all firms would either have the most co-efficient
operations or abandon the market
● In the long run, under perfect competition all firms need to be large enough
to reach minimum efficient scale (operations smaller than minimum
efficient scale or leave the market)
● DEMAND CURVE - The relationship between the price charged and the
maximum number of units that can be sold
● SHUTDOWN RULE - When the selling price per unit is as large as the
average variable cost per unit
● PROFIT MAXIMIZATION - Marginal revenue is equal to marginal cost
● FLAT DEMAND CURVE - Marginal revenue is equal to marginal price
Best operating level for the firm in response for the market price:
● If the price is too low to earn an economic profit at any possible operating
level, shutdown
● If the price is higher than the marginal cost when production is at the
maximum possible level in the short run, the firm should operate at that
maximum level
● Otherwise, the firm should operate at the level where price is equal to
marginal cost
● FIRM SUPPLY CURVES - The best response of sellers to market prices.
They are generally upward sloping. The upward sloping character reflects
that firms will be willing to increase production in response to a higher
market price because the higher price may make additional production
profitable
● FIRM DEMAND CURVES - Typically downward sloping to reflect that
consumer’s utility for a good diminishes with increased consumption
● MARKET SUPPLY CURVE - The relationship between the total quantity
provided and the market price
● As with FIRM SUPPLY CURVES - Market supply curves are generally
upward sloping and reflect both the willingness of firms to push production
higher in relation to improved profitability and the willingness of some firms
to come out of a short-run shutdown when the price improves sufficiently
● MARKET DEMAND CURVE - Indicates the maximum price that buyers will
pay to purchase a given quantity of a market product
● MARKET SUPPLY CURVE - Indicates the minimum price that suppliers
would accept to be willing to provide a given supply of a market product
● MARKET EQUILIBRIUM - Is the quantity and associated at which there is
concurrence between sellers and buyers. It occurs at the point where the
two curves intersect. (intersection of supply curve and demand curve)
TWO VARIATION OF PERFECT COMPETITION MODEL
1. MONOPOLISTIC COMPETITION - alters a different assumption of the
perfect competition model
2. CONTESTABLE MARKET MODEL - They maximize market shares (ex.
airlines)
DIFFERENCE BETWEEN PERFECT COMPETITION MODEL AND
MONOPOLISTIC COMPETITION
● They have the same assumption except number 4 - In Perfect Competition
mlModel, the goods may be homogeneous while in Monopolistic
 Competition, the goods are assumed to be heterogeneous - it has slight
variation or substitute product (ex. color, GPS, stereo etc.)
● COST LEADERSHIP STRATEGY - firms adopt an aggressive program to
either keep their costs below the costs of other sellers
● PRODUCT DIFFERENTIATION STRATEGY - keep their product
distinguishable from the competition
● MICHAEL PORTER - prevaid a guidebook for firms to prevail in these
competitive market in his text competitive strategy
● INVISIBLE HAND - the mechanism that moves a market to equilibrium as
a force
● If the Economic Losses exceed the Fixed Cost, SHUTDOWN
● SHORT-RUN OPERATION - Price below the minimum average variable
cost
● The Demand is negative (Inverse relationship)
● The Supply is positive (Direct relationship)
● PRODUCTION SURPLUS - Excess production
● CONSUMER SURPLUS - Excess bought
FORMULA OF DEMAND CURVE

Qd = a -bP
Q = dependent variable
P = independent variable

Example: Qd = 250 - 5P
250 - 5 (50)
Qd = 0

FORMULA OF SUPPLY CURVE

Qs = a + b (P)

Example: Qs = -350 + 10P Qs = - 350 + 10 (40) 50 = -350 + 10P

-350 + 10 (35) = -350 + 10 (40) -10P= -350-50
-350 + 350 = -350 + 400 -10P= -400
Qs = 0 Qs = 50 P= 40
MARKET EQUILIBRIUM

Qd = Qs

Example:
Qd = 100 - 60p, Qs = 28 + 3p

100 - 6p = 28 + 3p Qd = 100 - 6(8) Qs = 28 + 3(8)

100 - 28 = 6p + 3p = 100 - 48 = 28 + 24
72 = 9p = 52 = 52
9 9
p=8 P = 8, Q = 52

PRPDUCER SURPLUS
PS = MS (MARKET PRICE)
= 520 - 500
= 20 PS per item
Expected price = 500

● CETERIS PARIBUS - All variables are constant/same

● Another term for PRICE in graph is Y-AXIS
● Another term for Quantity in graph is X-AXIS