Perfect Competition: Microeconomics

CHAPTER
9
PERFECT
COMPETITION
MICROECONOMICS
Roger A. Arnold • Thirteenth Edition
©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.
©Sashkin/Shutterstock
9-1 The Theory of Perfect Competition
9-2 Perfect Competition in the Short Run
9-3 Perfect Competition in the Long Run
9-4 Topics for Analysis in the Theory of Perfect

Competition
2
©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©SashkinShutterstock
9-1 The Theory of Perfect Competition (1 of4)
• Market Structure: The environment whose characteristics

influence a firm’s pricing and output decisions
• Perfect Competition: A theory of market structure based on
four assumptions: (1) There are many sellers and buyers; (2)
the sellers sell a homogenous good; (3) buyers and sellers
have all relevant information; (4) entry into, and exit from, the
market is easy
• 9-1a A Perfectly Competitive Firm is a Price Taker
• Price Taker: A seller that does not have the ability to
control the price of the product it sells; the seller “takes” the
price determined in the market
3
9-1 The Theory of Perfect Competition (2 of 4)
• 9-1b The Demand Curve for a Perfectly Competitive Firm is

Horizontal
• Why Does a Perfectly Competitive Firm Sell at the
Equilibrium Price?
– If it tries to charge a price higher than the market-established
equilibrium, it won’t sell any of its products
– If the firm wants to maximize profits, it does not offer to sell at
a lower price
– See Exhibit 1
4
EXHIBIT 1
The Market Demand Curve and Firm Demand Curve in Perfect
Competition
5
• 9-1c Common Misconceptions about Demand Curves

– Many think that all demand curves must be downward sloping,
but this is not so
– A single perfectly competitive firm’s supply is so small,
compared with the total market supply, that the inverse
relationship between price and quantity demanded cannot be
observed on the firm’s level, only on the market level
• 9-1d The Marginal Revenue Curve of a Perfectly
Competitive Firm is the Same as Its Demand Curve
– Marginal Revenue (MR): The change in total revenue (TR)
that results from selling one additional unit of output (Q)
– For a perfectly competitive firm, P = MR
6
EXHIBIT 2
The Demand Curve and the Marginal Revenue Curve for a Perfectly
Competitive Firm
7
• 9-1e Theory and Real-World Markets

• The assumptions underlying the theory of perfect competition
are closely met in some real-world markets, such as some
agricultural markets and a small subset of retail trade; the
stock market also
• The four assumptions are also approximated in some real-
world markets; in them, the number of sellers may not be
large enough for every firm to be a price taker, but the firm’s
control over price may be negligible; the amount of control in
that market may be so negligible that the firm act as if it were
a perfectly competitive firm
• Therefore, the theory of perfect competition can be used to
predict that market’s behavior
8
• For the perfectly competitive firm, a price taker, price is equal

to marginal revenue (P=MR), and therefore the firm’s demand
curve is the same as its marginal revenue curve
• This section discusses the amount of output the firm will
produce in the short run
• 9-2a What Level of Output Does the Profit-Maximizing Firm
Produce?
• Profit Maximization Rule: Profit is maximized by
producing the quantity of output at which MR = MC
• Exhibit 3
9
EXHIBIT 3
The Quantity of Output That the Perfectly Competitive Firm Will
Produce
10
• 9-2b The Perfectly Competitive Firm and Resource Allocative

Efficiency
• Resource Allocative Efficiency: The situation in which
firms produce the quantity of output at which price equals
marginal cost: P = MC
• 9-2c To Produce or Not to Produce: That is the Question
• Case 1. Price is Above Average Total Cost (Ex 4a)
• Case 2. Price is Below Average Variable Cost (Ex 4b)
• Case 3. Price is Below Average Total Cost but Above
Average Variable Cost (Ex 4c)
11
EXHIBIT 4
Profit Maximization and Loss Minimization for the Perfectly
Competitive Firm: Three Cases
12
• 9-2d Common Misconceptions over the Shutdown Decision

• Even if price is below average total cost and a loss is being
incurred, a firm should not necessarily shut down; the
decision depends in the short run on whether the firm loses
more by shutting down than by not shutting down
– Even though price is below average total cost, it could still be
above average variable cost
– If it is, the firm minimizes its losses in the short run by
continuing to produce
13
• 9-2d Common Misconceptions over the Shutdown Decision

(cont)
14
EXHIBIT 5
What Should a Perfectly Competitive Firm Do in the Short Run?
15
EXHIBIT 6
Q&A about Perfect Competition
16
• 9-2e The Perfectly Competitive Firm’s Short-Run Supply

Curve
• Short-Run (Firm) Supply Curve: The portion of the
firm’s marginal cost curve that lies above the average
variable cost curve
• Short-Run Market (Industry) Supply Curve: The
horizontal sum of all existing firms’ short-run supply curves
17
EXHIBIT 7
The Perfectly Competitive Firm’s Short-Run Supply Curve
18
EXHIBIT 8
Deriving the Market (Industry) Supply Curve for a Perfectly
Competitive Market
19
• 9-2g Why is the Market Supply Curve Upward Sloping?

– 1. We draw market supply curves upward sloping because they are
the horizontal sum of firms’ supply curves and firms’ supply
curves are upward sloping
– 2. They are upward sloping because the supply curve for each
firm is the portion of its marginal cost (MC) curve that is above
its average variable cost (AVC) curve – and this portion of the
MC curve is upward sloping
– 3. MC curves have an upward-sloping portion because the MPP
of a variable input eventually declines. When that happens, the
MC curve begins to rise
• Because of the law of diminishing marginal returns, MC
curves are upward sloping, and because MC curves are upward
sloping, so are market supply curves
20
9-3 Perfect Competition in the Long Run (1 of 6)
• The number of firms in a perfectly competitive market may

not be the same in the short-run as in the long-run
• 9-3a The Conditions of Long-Run Competitive Equilibrium
• Long-Run Competitive Equilibrium: The condition in
which P = MC = SRATC = LRATC Economic profit is zero,
firms are producing the quantity of output at which price is
equal to marginal cost, and no firm has an incentive to
change its plant size
21
EXHIBIT 9
Long-Run Competitive Equilibrium
22
• 9-3b The Perfectly Competitive Firm and Productive

Efficiency
• Productive Efficiency: The situation in which a firm
produces its output at the lowest possible per-unit cost
(lowest ATC)
• 9-3c Industry Adjustment to an Increase in Demand
• An increase in market demand for a product can throw an
industry out of long-run competitive equilibrium (Exhibit
10)
23
EXHIBIT 10
The Process of Moving from One Long-run Competitive Equilibrium
Position to Another (1 of 2)
24
EXHIBIT 10
The Process of Moving from One Long-run Competitive Equilibrium
Position to Another (2 of 2)
25
• 9-3c Industry Adjustment to an Increase in Demand (cont)

• Long-Run (Industry) Supply (LRS) Curve: A graphic
representation of the quantities of output that an industry is
prepared to supply at different prices after the entry and exit
of firms are completed
• Constant-Cost Industry: An industry in which overage
total costs do not change as (industry) output increases or
decreases when firms enter or exit the industry, respectively
• Increasing-Cost Industry: An industry in which average
total costs increase as output increases and decrease as
output decreases when firms enter and exit the industry,
respectively
26
• 9-3c Industry Adjustment to an Increase in Demand (cont)

• Decreasing-Cost Industry: An industry in which average
total costs decrease as output increases and increase as
output decreases when firms enter and exit the industry,
respectively
• Exhibit 11
• 9-3d Profit from Two Perspectives
• From one perspective, profit serves as an incentive for
individuals to produce
• From another perspective, it serves as a signal, identifying
where resources are most welcome
27
EXHIBIT 11
Long-Run Industry Supply Curves
28
• 9-3e Industry Adjustment to an Increase in Demand

• Suppose market demand decreases; in the short run the equilibrium price
falls, shifting the firm’s demand curve (marginal revenue curve)
downward
• Some firms in the industry then decrease production; in the long run,
some firms will leave the industry
• 9-3f Differences in Costs, Differences in Profits: Now You See It, Now
You Don’t
• Assume two farmers, Cordero and Hancock, who produce wheat,
Cordero on fertile land, Hancock in poor soil; both sell for the same
price, but Cordero has lower average total costs, thus earns profits;
Hancock does not
• But individuals will bid up the price of Cordero’s land, increasing costs
so that eventually, he will be in the same situation as Hancock (Exhibit
12)
29
EXHIBIT 12
Differences in Costs, Differences in Profits: Now You See It, Then
It’s Gone
30
• 9-3g Profit and Discrimination

• A firm’s discriminatory behavior can affect its profits in the
context of the model of perfect competition
• Suppose that under the conditions of long-run competitive
equilibrium (zero profits), the owner of a firm chooses not
to hire an excellent worker because of that worker’s race,
religion or gender; what happens?
– His costs will rise above those of competitors who hire
the best employees without regard to race, religion, etc.
– Because he is earning zero profit, the act of
discrimination will raise TC and put the firm into taking
economic losses; if he is a manager, he may lose his job
because of subnormal profits
31

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CHAPTER

9-2 Perfect Competition in the Short Run

9-3 Perfect Competition in the Long Run

9-4 Topics for Analysis in the Theory of Perfect

• Market Structure: The environment whose characteristics

• 9-1b The Demand Curve for a Perfectly Competitive Firm is

• 9-1c Common Misconceptions about Demand Curves

• 9-1e Theory and Real-World Markets

• For the perfectly competitive firm, a price taker, price is equal

• 9-2b The Perfectly Competitive Firm and Resource Allocative

• 9-2d Common Misconceptions over the Shutdown Decision

• 9-2d Common Misconceptions over the Shutdown Decision

What Should a Perfectly Competitive Firm Do in the Short Run?

Q&A about Perfect Competition

• 9-2e The Perfectly Competitive Firm’s Short-Run Supply

The Perfectly Competitive Firm’s Short-Run Supply Curve

• 9-2g Why is the Market Supply Curve Upward Sloping?

• The number of firms in a perfectly competitive market may

Long-Run Competitive Equilibrium

• 9-3b The Perfectly Competitive Firm and Productive

• 9-3c Industry Adjustment to an Increase in Demand (cont)

• 9-3c Industry Adjustment to an Increase in Demand (cont)

Long-Run Industry Supply Curves

• 9-3e Industry Adjustment to an Increase in Demand

• 9-3g Profit and Discrimination

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