PERFECT COMPETITION

VAIBHAV BHAMORIYA
SESSION 12, MANAGERIAL ECONOMICS
IIM KASHIPUR, PGP 2018-19
OPTIMAL PRICE , OUTPUT AND ADVERTISING

• Perfect Competition
• Where managerial decisions have no perceptible impact on market price

• Key Conditions
• Many small buyers and sellers
• Each firm produces a homogenous product
• Buyers and seller have perfect information
• Free entry and exit from the market
• No transaction costs

• All firms charge the same price and the price is determined by interaction of all buyers and sellers in the
market.
 DEMAND – MARKET AND FIRM LEVEL
(PERFECT COMPETITION)
• No single firm influences price
• With even a slight change in price consumers shift to one of the many substitute products
• Equilibrium price is given by the intersection of market demand and supply curves
• The firm can sell as much as it wants at the eqbm. Price – deciding output is the challenge
• The demand curve facing an individually perfectly competitive firm is a horizontal straight
line
• Even if the firm charged slightly higher than the market price it would sell nothing
SHORT RUN OUTPUT DECISION

• Maximising Profits
• The marginal revenue for a competitive firm is the market price
• MR = dR/dQ
SHUT DOWN AND BREAK EVEN POINTS

• All firms make zero economic profit in a perfectly competitive market

• Accounting profits are made just enough to cover implicit costs of production
• If P>= AVC the firm will incur losses in the short run but continue to produce hoping for
revenues to increase or costs to go down.. Also some part of fixed costs is being
recovered P>AVC
• If P<AVC every unit produced adds losses and the fixed costs are also not recovered
hence it makes sense to shut down
PRODUCTION CONDITIONS

• Short Run – the firm should produce in the range where

• P=MC
• P≥ AVC

• Long Run
• Due to free entry new firms will enter lowering eqbm price or exit increasing eqbm price
• P=MC
• P = minimum of Average Cost
SUPPLY CURVES

• Short Run
• For a perfectly competitive firm in the short run , The supply curve is the range of the
MC curve above the minimum of the AVC curve.
• The horizontal sum of the MC of all the firms determines the total output of the market at
each price and hence the supply curve of the industry
EXAMPLE

• C(Q) = 100 + Q2 P=10

• MC =2Q P=MC -------- Q*=5

• AVC for 5 units =VC / Q* = Q2/ 5 = 5

• P=10 and AVC =5 The firm should continue to produce in the short run
• Loss = PQ*- C(Q) = 10x5 – (100+52) = 50-125 = 75
• Loss < Fixed cost !!!
EXAMPLES

• Betamax and VHS

• Time Warner Boosts My Speed, Cuts My Bill
• Are these perfectly competitive markets