Chapter 7

Market
Structure:
Perfect
Competition
ESMA 794
Economics for Managers
Spring 2024
Ahmad Mayyas
Khalifa University
Department of Management Science & Engineering
© 2014 Pearson Education, Inc.
 chapter 7
Market Structure: Perfect Competition

TABLE 7.1 Market Structure.

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Characteristics of the Model of Perfect Competition

• Price-taker: A characteristic of a perfectly competitive
market in which the firm cannot influence the price of
its product, but can sell any amount of its output at
the price stablished by the market.

• In a perfectly competitive market, products are

undifferentiated. This market characteristic means
that consumers do not care about the identity of the
specific supplier of the product they purchase

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Model of Perfect Competition

The Model of Perfect Competition:

The perfectly competitive firm takes
the equilibrium price set by the
market and maximizes profit by
producing where price, which also
equals marginal revenue, is equal
to marginal cost. The level of profit
earned depends on the relationship
between price and average total
cost.

FIGURE 7.1 The Model of Perfect Competition.

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Marginal revenue for the perfectly competitive firm

• Marginal revenue for the perfectly competitive firm:

The marginal revenue curve for the perfectly
competitive firm is horizontal because the firm can
sell all units of output at the market price, given the
assumption of a perfectly elastic demand curve.

Price equals marginal revenue for

the perfectly competitive firm.

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Profit-Maximizing Level of Output

EQUATION 7.1 Determining the

Profit-Maximizing Level of Output

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Profit-Maximizing Level of Output

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Profit-Maximizing Level of Output

TABLE 7.2 Calculation of Profit

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Profit-Maximizing Level of Output

P0, the price that equals

the firm’s minimum
average variable cost, is
the shutdown point for
the perfectly
competitive firm.

FIGURE 7.2 The Supply Curve for the Perfectly Competitive Firm
© 2014 Pearson Education, Inc.
 chapter 7
Market Structure: Perfect Competition

Supply Curves for the Perfectly Competitive Market

• Supply curve for the perfectly competitive firm: The
portion of a firm’s marginal cost curve that lies above
the minimum average variable cost.

• Supply curve for the perfectly competitive industry:

The curve that shows the output produced by all
perfectly competitive firms in the industry at
different prices.

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

TABLE 7.3 Numerical Example Illustrating the Perfectly Competitive Firm (Q measured in units; all
costs, revenues, and profits measured in dollars)

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Long-Run Adjustment in Perfect Competition:

Entry and Exit

Equilibrium point for the

perfectly competitive firm: The
point where price equals
average total cost because the
firm earns zero economic profit
at this point. Economic profit
incorporates all implicit costs of
production, including a normal
rate of return on the firm’s
investment.
FIGURE 7.2 The Supply Curve for the Perfectly Competitive Firm
© 2014 Pearson Education, Inc.
 chapter 7
Market Structure: Perfect Competition

Long-Run Adjustment in Perfect Competition:

Entry and Exit
• An increase in industry demand will result in a positive economic profit for a perfectly
competitive firm. However, this profit will be competed away by the entry of other firms
into the market in the long run.
• The zero economic profit point or the point where price equals average total cost (ATC)
is the equilibrium point for the perfectly competitive firm.

© 2014 Pearson Education, Inc.

FIGURE 7.3 Long-Run Adjustment in Perfect Competition: Entry and Exit
 chapter 7
Market Structure: Perfect Competition

Long-Run Adjustment in Perfect Competition

Adjustment in the Potato Industry
• The original equilibrium at point A in Figures 7.4a and 7.4b shows the high price ($8.00
per 100-pound sack) and profits for potato farmers in 1995.
• In response to these profits, farmers planted more potatoes in 1996, shifting the
supply curve from S95 to S96.
• This increase in supply drove the price down to $2.00 per 100-pound sack (point B),
less than the average total cost for many producers, leaving farmers with heavy debts.

© 2014 Pearson Education, Inc. FIGURE 7.4 Adjustment in the Potato Industry
 chapter 7
Market Structure: Perfect Competition

Long-Run Adjustment in Perfect Competition

The Optimal Scale of Production
Long-Run Adjustment in Perfect Competition: Optimal Scale of Operation: In the
long run, the perfectly competitive firm has to choose the optimal scale of operation. This
decision, combined with entry and exit, will force price to equal long-run average cost.

FIGURE 7.5 Long-Run Adjustment in Perfect Competition: The Optimal Scale of Operation
© 2014 Pearson Education, Inc.
 chapter 7
Market Structure: Perfect Competition

Summary
• Perfect competition is a form of market structure in which individual
firms have no control over product price, which is established by
industry or market demand and supply.
• In the short run, perfectly competitive firms take the market price and
produce the amount of output that maximizes their profits.
• Profits earned in the short run can be positive, zero, or negative.
• Perfectly competitive firms are not able to earn positive economic
profits in the long run because these profits will be eroded by entry of
other firms. Likewise, any losses will be removed by firms leaving the
industry.
• To lower their costs, firms also seek to produce at the optimal scale of
operation. However, this scale will be adopted by all firms in the long
run, and entry will force prices to equal long-run average cost, the zero-
economic profit equilibrium.
© 2014 Pearson Education, Inc.
 chapter 7
Market Structure: Perfect Competition

Other Types of the Supply Curve

The aggregate supply relationship for all farm output in most countries is very
price inelastic in the short run

The elasticity of supply

for a farm product will
vary with the price of the
product.

FIGURE 7.A1 Representative Supply Curve for a Farm Product

© 2014 Pearson Education, Inc.
 chapter 7
Market Structure: Perfect Competition

Problem- EoC 7.1

For each of the following graphs, identify the firm’s profit-maximizing (or loss-
minimizing) output. Is each firm making a profit? If not, should the firm continue to
produce in the short run?

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Solution

In all three graphs, the profit-maximizing (or loss- minimizing)

output occurs where marginal revenue equals marginal cost. In part:
(a) The firm is not making a profit, as P < ATC, but P > AVC, so it is
covering variable costs and, thus, should continue to produce in
the short run.
(b) The firm is making a profit because P > ATC.
(c) The firm is not making a profit, as P < ATC, and is not covering
variable costs because P < AVC; thus, it should shutdown

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Problem- EoC 7.2

• Consider a firm in a perfectly competitive industry. The firm
has just built a plant that cost $15,000. Each unit of output
requires $5 worth of materials. Each worker costs $3 per hour.
a. Based on the information above, fill in the table.
b. If the market price is $12.50, how many units of output will
the firm produce?
c. At that price, what is the firm’s profit or loss? Will the firm
continue to produce in the short run? Carefully explain your
answer.
d. Graph your results.

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Solution
a.

15000 0 15000

15000 575 15575 5.75 5.75 155.75

15000 900 15900 6.5 6.00 106.00

15000 1100 16100 8.00 6.28 92.00

15000 1275 16275 8.75 6.53 83.46

15000 1400 16400 12.50 6.82 80.00

15000 1500 16500 20.00 7.14 78.57

15000 1585 16858 42.50 7.47 78.23

b. The firm will produce 205 units.

c. The firm’s profit is [(12.50)(205)] – 16,400 = 2,562.50 – 16,400 = –
$13.837.50. The firm is losing money, but if it were to shut down, it would lose
$15,000 (its fixed costs); thus, the loss-minimizing choice is to stay in business
in the short run (as P > AVC).
© 2014 Pearson Education, Inc.
 chapter 7
Market Structure: Perfect Competition

Problem- EoC 7.4

Consider the following graph, which shows a demand curve and
two supply curves. Suppose that there is an increase in demand.
Compare the equilibrium price and quantity change in both
cases, and use those results to explain what you can infer about
the elasticity of supply.

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Solution

Supply curve S2 is more elastic than supply curve

S1. We can infer this because, for a given change
in price, the change in quantity supplied is far
greater on supply curve S2 (in other words, a
given percentage change in price leads to a
larger percentage change in quantity supplied).

© 2014 Pearson Education, Inc.

 chapter 7
Market Structure: Perfect Competition

Problem- EoC 7.6

• The following graph shows the long-run average cost curve for a firm in a
perfectly competitive industry. Draw a set of short-run cost curves consistent
with output QE and use them to explain
• a. Why the only output that a competitive firm will produce in the long run is QE
• b. Why it will be a profit-maximizing decision to produce more than QE in the
short run if the price exceeds PE
MC
Solution:
SATC1
P<SATC1: firm is incurring a loss. Firm may start
thinking of producing less Q SATC3 LAVC
SATC2
P=SATC2: breakeven point. This firm can cover
avg. total cost with this market equilibrium
price (zero economic profit at this point)
Exit the market
since P<LAVC
P>SATC3: firm is generating good profit
© 2014 Pearson Education, Inc.