Perfect Competition

P sivakumar
Economics Faculty
INC-Coimbatore

Market
Market is a place where buyers and
seller gather in order to buy and
sell a particular goods or
commodity. It is not restricted to a
building, place or area.
Kinds of Market
Perfect
Competition

Monopoly

Monopolistic
Competition

Oligopoly

Perfect Competition
a) large number of buyers and sellers
b) product homogeneity
c) free exit and entry of firms
d) profit maximization
e) no government regulation
f) perfect mobility of factors of production
g) perfect knowledge
h) absence of transport cost

Supply and Demand in

Perfect Competition
Industry
Y
Price

S
E

P
S
O

Firm
Y
Price
AR =
MR

P
D

Quantit
y

X O

X
Quantit
y

Demand curve of perfect

competition
The demand curve in perfect
competition is infinitely elasticity
which indicates that the firm can
sell any amount of output at the
prevailing market price.
P

AR =MR

o
output

Equilibrium conditions

MC = MR
MC should cut MR from below
If the above two conditions fulfilled
then firm said to be in equilibrium

Short run Equilibrium

TR & TC Method
In this method a firm is in equilibrium when
it maximizes its profit, defined as the
difference between total cost and total
TC
revenue.
TR
Loss

Max
of
profit
loss

Xa

Xe

Xb

Short Run Equilibrium

of the Firms

Super Normal Profit

when AR>SAC
Normal Profit
when AR=SAC
Minimum Loss
when AR=SAVC but AR<SAC

Measuring Profit if P > ATC

price

ATC

MC
d = MR
profit

Quantity

Measuring Loss if P < ATC

price

MC
ATC
loss

d = MR
1

Quantity

Marginal revenue & marginal

cost method
In the short run firm can earn normal profit,
super normal profit and also losses.
MC

MC
MC
AC

e
AR=MR

p
p1

AC

e
e1

AR=MR

e1

p1
p

AC

Industry equilibrium in the

short run
Given the market demand and the
market supply the industry is in
equilibrium at that price at which the
quantity demanded is equal to the s
d
quantity
supplied.
Mc Ac
Mc
Ac
p
p1

p1

e1

e
p

e1

s
q1

q2

Long run equilibrium of

industry
The industry is in equilibrium in the long run
when price is reached at which all firms are in
equilibrium. The industry produces at the
minimum point of LAC curve and makes only
normal profit.
d

LMC

SAC

SMC

p
s

o
Q

LAC

Shut Down cost / Pricing

In short run the firm may continue its

production process, even if it incurs
loss
The maximum amount of loss that
the firm is willing to bear in the short
run equal to the total fixed costs
When a firm fails to recover its total
variable costs, the firm will stop its
production

Short-Run Supply Under Perfect

Competition
(a)

(b)

Dollars

Price per
ATC

MC

Bushel

d1=MR1

$3.50

2.50
2.00 AVC

d2=MR2
d3=MR3

2.50
2.00

1.00
0.50

d4=MR4
d5=MR5

1.00
0.50

$3.50

1,000
4,000
7,000 Bushels
per Year
2,000
5,000

Firm's Supply
Curve

Bushels

2,0004,000 7,000 per Year

5,000

Deriving The Market Supply Curve

3.The total supplied by all firms at different
prices is the market supply curve.

1. At each price . . .

Market

Firm
Price per
Bushel

Firm's Supply Curve

Price per
Bushel

$3.50

$3.50

2.50
2.00

2.50
2.00

1.00
0.50

1.00
0.50
2,000 4,000
7,000 Bushels
per Year
5,000

2. the typical firm supplies the

profit-maximizing quantity.

Market Supply
Curve

400,000 700,000 Bushels

per Year
200,000 500,000

IN THE LONG RUN

When demand increases from D0 to D1, entry occurs and the

market supply curve shifts from S0 to S1. The long-run market
supply curve, LSA, is horizontal.

13.3 IN THE LONG RUN

When demand increases from D0 to D2, entry occurs and the

market supply curve shifts from S0 to S2. The long-run market
supply curve, LSB, is upward slopingexternal diseconomies.

13.3 IN THE LONG RUN

When demand increases from D0 to D3, entry occurs and the

market supply curve shifts from S0 to S3. The long-run market
supply curve, LSC, is downward slopingexternal economies.

Efficiency of
Competitive markets
When allocation of resources results in
maximum possible net benefit
Properties of allocative efficency
(a) Efficient allocation of resources among
firms ( Equilibrium of production)
(b) Efficient distribution of goods
(Equilibrium of consumption)
Efficient combinations of products
(simultaneous Equi of production &
consumption)

When an efficient allocation of

resources have been attained, it is
not possible to make any person in
the society better-off without
making someone else worse-off
Any changes in the productive
methods or further exchange of
goods and services can not result
in additional net gains if resources
are efficiently allocated

MC
MC ,P,Marginal benefit
15

10
5

E
A
Marginal benefit

50

75
Loves of bread per day

Efficient Output of a Good

The maximum price a buyer will

pay for another unit of a good is
called the marginal benefit of the
good.
The minimum price a seller will
accept for making another unit
available is its marginal cost.

The marginal benefit is assumed to

decline with consumption of bread,
while the marginal cost is assumed
to increase.
Net gain = MB > MC ( point B)
producer better-off
At point A consumers would be
better-off
At point E mutual gains is possible

Effect of Taxes on Price

and Quantity

Imposition of a Lump
Sum Tax
Imposition of a Profit Tax
Imposition of a Specific
Sales Tax

Imposition of a Lump Sum

Tax

Increase in fixed cost

Upward shift of AFC and AC curves
AVC and MC do not affected
In short run no effect on
equilibrium
In long run supply will decrease
and price will increase

Imposition of a Profit Tax

Effects are same as those of a

lump sum tax
No effect on MC and short run
equilibrium of the firm and
industry
In long run supply will decrease
and price will increase

Imposition of a Specific
Sales Tax

It affects MC curve of a firm

Burden of tax on consumer depends
on price elasticity of supply with
given demand
The more elastic supply, the higher
burden of a specific tax on
consumer and less the burden on
the firm

Market supply is perfectly elastic

entire tax burden goes to
consumers
Supply curve is negative one then
imposition of specific tax results in
an increase in price, which is
greater than tax