In The Name of Allah, The Most Beneficent, The Most Merciful

Basic Economics
Market Structures:
Perfect Competition

Dr. Sayyid Salman Rizavi

 Market
• Market includes all places, real or virtual, where buying and
selling may take place
• Markets are classified according to some characteristics
• Usually we first look at the number of sellers, however other
characteristics matter
Market Number of Other main
Sellers characteristics
Monopoly One
Duopoly Two
Oligopoly Few Collusive or non-
collusive
Monopolistic Competition Large Product
/ Imperfect Competition Differentiation
Perfect Competition Very large Homogeneous
(infinite) Products
 Market Equilibrium
•• All
  firms try to maximize profits
• Profit = Total Revenue – Total Cost

Maximum profit is where the

 

Profit
  =0
first derivative is zero m,

OR
MR = MC
Second order condition dictates that
Slope of MC > Slope of MR Q Output
 Perfect Competition
• “The market structure in which there are many sellers and
buyers. The firms produce a homogeneous product and there is
free entry and exit of these firms to and from the industry.”
• Features / Characteristics
1. Large number of sellers and buyers
2. Low market share of individual firm
3. Firm can not control price. Price is fixed by market demand
and supply
4. Uniform price (firm’s perspective)
5. Homogeneous products
6. Perfect knowledge and perfect mobility
7. Free Entry and Exit of firms
 Perfect Competition: Revenues
Output (Q) Price (P) TR = P.Q
1 10 10 10
12 10
10 10
20 10
10
23 10
10 20
30 10
10
34 10
10 30
40 10
10
45 10
10 40
50 10
10
5 10 50 10

  𝑻𝑹 𝑷𝑸
Price, revenue

𝑨𝑹= = =𝑷
𝑸 𝑸
MR=AR=P

MR=AR=P

Output
 Perfect Competition: Price Determination

The demand and supply forces in

the industry determine the market
Price equilibrium price P1, at which the Price
firm is forced to sell its product.
The firm can sell any quantity (Q1 S
or Q2, etc.) at price P1.

 𝑃1
MR=AR=P
e
 𝑃1

𝑄1 𝑄2
Output Output
  Firm
 
Industry
 Perfect Competition: Firm’s Equilibrium

Price, Costs

MR=AR=P=MC
c
𝑀𝐶
 
a e

𝑃
MR=AR=P
  d

Output
O

𝑞1
  q
𝑞2
 
 Perfect Competition: Short run Equilibrium –
Normal Profit / Break-Even
At the point where MC = MR,
Price the firm is in equilibrium
Costs
Revenues
MC At this point the output is Q and
price is P

Average Revenue (AR) is the

AC
AVC
price (P)
P MR=AR=P

Average Cost is also equal to

price in this case

AR = AC and the firm is earning

O
normal profit
Q Output

Normal profit is already

included in Cost
 Perfect Competition: Short run Equilibrium –
Abnormal / Super Normal Profit
At the point where MC = MR,
the firm is in equilibrium
Price
MC
Costs
Revenues
At this point the output is Q and
price is P
e
P MR=AR=P Average Revenue (AR) is the
a
AC
price (P)
C AVC

Average Cost is C

AR > AC and the firm is earning

more than normal profit
O
Q Output Shaded area shows abnormal
profts
 Perfect Competition: Short run Equilibrium –
LOSS
At the point where MC = MR,
the firm is in equilibrium
MC

Price
At this point the output is Q and
Costs price is P
Revenues
AC
c
a Average Revenue (AR) is the
AVC price (P)
e
P MR=AR=P

Average Cost is C

AR < AC and the firm is earning

more than normal profit
O q Output Shaded area shows the Loss
 Perfect Competition: Long run Equilibrium

Price
Costs
Revenues S2

MR2=AR2=P2 f S1
P2

e S2
P1
MR1=AR1=P1

P3 MR3=AR3=P3
g

O O
Output Q
 Perfect Competition: Long run Equilibrium

At the point where LMC = MR,

Price
Costs
the firm is in equilibrium
Revenues LMC
At this point the output is Q and
SMC
price is P
SAC
LAC

MR=AR=P
Average Revenue (AR) is the
P
price (P)

Average Cost is equal to P

AR = LAC and the firm is

O
Q Output earning normal profit