Module: Business Economics

Lesson: Four Market Models – Perfect

competition

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Four Market Structures

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 Pure Competition
Characteristics & Occurrence
• Very large Numbers
– Large number of independently acting sellers
– Offering their products national and international markets
• Standardized Product
– Purely competitive firms produce identical or homogeneous product
– As long as price is equal consumer will be indifferent about sellers
• Price takes
– No significant control over product price
– It cannot change market price
– Asking higher price than the market price is useless
• (firm A selling $2.05 when other 9999 companies sell same good for $ 2)
• Free entry and Exit
– No significant legal, technological, financial or other prohibitions for new
firms to sell their products

3
 Perfectly Elastic Demand
• Demand curve of the competitive firm is perfectly
Elastic
• Firms cannot obtain a higher price by restricting its
output nor does it lower its price increasing it’s sales

• We are saying market Demand is

not Elastic perfectly
– Agricultural
Inelasticproductstotal-demand curves
• Demand schedule
quite face by the individual firm
in
a purely competitive industry (perfectly Elastic)
4
 Average, Total & Marginal
Revenue
• Average Revenue
– Firms D schedule is also its revenue schedule
– P per unit to purchaser is also revenue per
unit or average revenue
• Total Revenue
– Multiply the P level by the Q sold
• Marginal Revenue
– Extra revenue gets by selling one unit of
output
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 Profit Maximization
in the Short-Run
• Competitive firms are price takers
• They can make Economic profit only
by
adjusting output
• In short-Run
Company canfirm has Fixed
change it plant capacity
out put only by
• change variables of resources
(materials and labor) used
•Two ways to calculate maximum profit (or
minimum
loss)
– Compare TR and TC
– Compare MR and MC 6
 TR , TC Approach:
Profit-Maximization
Case
• Competitive products should ask following
question
• Should we produce this product?
• If so, in what amount?
• What economic profit (loss) will we realize?
• Break even point
– An output at which makes normal profit
but not
aneconomic profit
– Any output between 2 break even points makes
will produce economic Profit
• Firms maximum profit = greatest distance of TR
and TC curves 7
8
 Competitive Production -
Answering 3 Questions
• Should we produce
this
product?
– Of course, it can realize
a profit by doing so
• If so, in what amount?
– 9 units, where
economic profit is
maximum
• What economic
profit (loss) will we
realize?
9
– $ 299 economic profit ($
 MR = MC
Rule
• When the output is relatively MR usually (not
always)
low exceed MC (profitable)
•output is relatively high MC exceed MR (loss)
•Output determine rule (MR=MC Rule)
– In the short-run, the firm will maximize profit or minimize loss by
producing the output at which MR=MC (as long as
producing preferable to shutting down {supply curve})
•Characteristics of the rule
•apply only when producing preferable to shutting down
•An accurate guide to profit maximization for all firms
•Rule can be restated P=MC
– When producing is preferable to shutting down, the
competitive firm that wants to maximize its profit or minimize
its loss should produce at that point where price equal marginal
cost (P=MC)
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Profit Maximize Output For A
Purely Competitive Firm:
MR-MC Approach (P= $ 131)
Total AFC $ AVC $ ATC $ MC $ P = MR $ Profit (+)
Product Loss (-)
0 -100
1 100 90 190 90 131 -59
2 50 85 135 80 131 -8
3 33.33 80 113.33 70 131 +53
4 25 75 100 60 131 +124
5 20 74 94 70 131 +185
6 16.67 75 91.67 80 131 +236
7 14.29 77.14 91.43 90 131 +277
8 12.50 81.25 93.75 110 131 +298
9 11.11 86.67 97.78 130 131 +299
10 10 93 103 150 131 +280

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 Short-run Profit Maximizing
Position Of A Purely
Competitive Firm

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 Loss Minimizing/Shutdown
Case…
• Assume instead of market P = $131 now market
P=
$ 81 (loss minimize) and market P =
$ 71
(shutdown)

• Loss minimize case

– Should firm produce? YES
– How much? 6 UNITS
– Will they make profit or loss?A LOSS OF $ 64

• Shutdown case
– Should firm produce? NO 13
 Loss Minimizing Outputs / Shutdown
For A Purely Competitive Firm: MR,MC
Total AFC $ AVC $
Approach
ATC $ MC $ P = MR Profit (+) P = MR Profit (+)
Product $ 81 Loss (-) $ 71 Loss (-)
$ 81 $ 71
0 -100 -100
1 100 90 190 90 81 -109 71 -119
2 50 85 135 80 81 -108 71 -128
3 33.33 80 113.33 70 81 -97 71 -127
4 25 75 100 60 81 -76 71 -116
5 20 74 94 70 81 -65 71 -115
6 16.67 75 91.67 80 81 -64 71 -124
7 14.29 77.14 91.43 90 81 -73 71 -143
8 12.50 81.25 93.75 110 81 -102 71 -182
9 11.11 86.67 97.78 130 81 -151 71 -241
10 10 93 103 150 81 -220 71 -320

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Short-run Loss Minimizing
Position Of A
Purely Competitive
firm

15
Short-run Shutdown Position Of
A Purely Competitive Firm

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 MC and Short-Run Supply
Pric e Quantity Max. Profit (+) Generalized Depiction
($) Supply / Min. loss (-)

151 10 + 480

131 9 + 299

111 8 + 138 Firm will get economic profit. Any

price above 91 earn economic profit

91 7 -3 91 is break even point. Normal profit

not economic profit
81 6 - 64 81 minimize short-run loss
MR=MC supply 6 units
71 0 - 100 71 = Min. AVC so shutting down case

61 0 - 100 61 below the min. AVC won’t Produce

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 Firm and Industry Equilibrium
Price
Assume there are 1000 suppliers at any level of price level
and there is various demand on each price level
Quantity Supply QS 1000 firms Price ($) QD
10 10000 151 4000
9 9000 131 6000
8 8000 111 8000
7 7000 91 9000
6 6000 81 11000
0 0 71 13000
0 0 61 16000

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