Perfect

Competition
Chapter 11
 A Perfectly
Competitive Market
• A perfectly competitive market is one in
which economic forces operate unimpeded.
 A Perfectly
Competitive Market
• A perfectly competitive market must meet the
following requirements:

● Both buyers and sellers are price

takers.
● The number of firms is large.
● There are no barriers to entry.
● The firms’ products are identical.
● There is complete information.
● Firms are profit maximizers.
 Conditions for Perfect
Competition
• Both buyers and sellers are price takers.
o A price taker is a firm or individual who takes the market price as
given.
o In most markets, households are price takers – they accept the price
offered in stores.
 Market Demand Versus
Individual Firm Demand Curve
Market Firm
Price Market supply Price
$10 $10
8 8 Individual firm
6 6 demand
4 Market 4
2 demand 2

0 0
1,000 Quantity
3,000 10 20 30 Quantity
Profit-Maximizing Level
of Output
• The goal of the firm is to maximize profits.
• Profit is the difference between total revenue and
total cost.
Profit-Maximizing Level
of Output
• What happens to profit in response to a change in
output is determined by marginal revenue (MR)
and marginal cost (MC).

■ A firm maximizes profit when MC = MR.

Profit-Maximizing Level
of Output
• Marginal revenue (MR) – the change in total
revenue associated with a change in quantity.

■ Marginal cost (MC) – the change in total

cost associated with a change in quantity.
 Marginal Revenue
• A perfect competitor accepts the market price as
given.
• As a result, marginal revenue equals price (MR =
P).
 Marginal Cost
• Initially, marginal cost falls and then begins to
rise.
• Marginal concepts are best defined between the
numbers.
 Profit Maximization: MC = MR
• To maximize profits, a firm should produce where
marginal cost equals marginal revenue.
How to Maximize Profit
• If marginal revenue does not equal marginal cost,
a firm can increase profit by changing output.
• The supplier will continue to produce as long as
marginal cost is less than marginal revenue.
How to Maximize Profit
• The supplier will cut back on production if
marginal cost is greater than marginal revenue.

■ Thus, the profit-maximizing condition of a

competitive firm is MC = MR = P.
 Curve Is the Supply
Curve
• The marginal cost curve is the firm's supply curve
above the point where price exceeds average
variable cost.
 Curve Is the Supply
Curve
• The MC curve tells the competitive firm how
much it should produce at a given price.

■ The firm can do no better than produce

the quantity at which marginal cost equals
marginal revenue which in turn equals
price.
 Curve Is the Firm’s
Supply Curve
$70 Marginal cost
C
60
50
Cost, Price

40 A
30
20 B

10
0 1 2 3 4 5 6 7 8 9 10 Quantity
 Using Total Revenue
and Total Cost
• Profit is maximized where the vertical distance
between total revenue and total cost is greatest.
• At that output, MR (the slope of the total revenue
curve) and MC (the slope of the total cost curve)
are equal.
 Profit Determination Using
Total Cost and Revenue Curves
TC TR
$385 Loss
Total cost, revenue

350
315 Maximum profit =$81 Profit
280
245
210 $130
175
140
105 Profit =$45
70
35 Loss
0
1 2 3 4 5 6 7 8 9 Quantity
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All
Rights Reserved.
 Profit-Maximizing Level
of Output
• The P = MR = MC condition tells us how much
output a competitive firm should produce to
maximize profit.
• It does not tell us how much profit the firm makes.
 Loss From a Table of
Costs
• Profit can be calculated from a table of costs and
revenues.
• Profit is determined by total revenue minus total
cost.
Determining Profit and
Loss From a Graph
• Find output where MC = MR.
o The intersection of MC = MR (P) determines the quantity the firm will
produce if it wishes to maximize profits.
Determining Profit and
Loss From a Graph
• The firm makes a profit when the ATC curve is
below the MR curve.

■ The firm incurs a loss when the ATC curve

is above the MR curve.
 Determining Profit and Loss
From a Graph
• Zero profit or loss where MC=MR.

● Firms can earn zero profit or even a loss

where MC = MR.
● Even though economic profit is zero, all
resources, including entrepreneurs, are
being paid their opportunity costs.
 Determining Profits
Graphically
Price MC Price MC Price MC
65 65 65
60 60 60
55 55 55
50 50 50 ATC
45 45 ATC 45
40 D A P = MR 40 40 Loss P = MR
35 35 35
Profit P = MR
30 B ATC 30 30 AVC
25 C AVC 25 AVC 25
20 E 20 20
15 15 15
10 10 10
5 5 5
0 0 0
1 23 4 5 67 891012 1 23 4 5 67 891012 1 23 4 567 89 1 12
Quantity Quantity Quantity 0
a) Profit case (b) Zero profit case (c) Loss case

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2000

 The Shutdown Point
• The firm will shut down if it cannot cover average
variable costs.
o A firm should continue to produce as long as price is greater than
average variable cost.
o If price falls below that point it makes sense to shut down temporarily
and save the variable costs.
 The Shutdown Point
• The shutdown point is the point at which the
firm will be better off it it shuts down than it will if
it stays in business.
 The Shutdown
Decision
MC
Price
60

50 ATC

40 Loss
P = MR
30
AVC
20
$17.80 A
10

0
2 4 6 8 Quantity
 Short-Run Market
Supply and Demand
• While the firm's demand curve is perfectly elastic,
the industry's is downward sloping.
• For the industry's supply curve we use a market
supply curve.
 Long Run to the Short
Run
• Industry supply and demand curves come
together to lead to long-run equilibrium.
An Increase in Demand
• The original firms return to their original output
but since there are more firms in the market, the
total market output increases.

• An increase in demand leads to higher prices and

higher profits.
o Existing firms increase output.
o New firms enter the market, increasing output still more.
o Price falls until all profit is competed away.
 Market Response to an
Increase in Demand
Price Market Price Firm
MC
S0SR
S1SR AC
B B
$9 $9
C Profit
7 SLR 7
A
A

D1
D0
0 1,200Quantity
700 840 0 1012Quantity
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All
Rights Reserved.
 An Example in the Pakistani
Market of Perfect Competition
• Pakistan has a huge potential for telecom growth
• Pakistan was ranked as a key destination for
telecom growth
• Telecommunication sector has characteristic of
perfect competition :
o Large number of buyers and sellers
o Free entry and exit
o Knowledge of the product among the people

• Due to increased competition between 5 major

companies – price is of a lesser competition
compared to service and features
 An Example in the Pakistani
Market of Perfect Competition
• In the beginning due to high tax on purchase of
SIM cards – the market was slow
• When these taxes were lifted, the market started
to grow rapidly and more investments poured in
• Together the internet service industry is also on
the rise which has attracted investors as well
 Market Share
of Cellular Companies
Change / Increase in Subscribers
Change in December – 2010
 Conclusion
• Zong capturing a greater market share by
promotion cheap calls throughout Karachi – “
Apna Karachi” package.
• Zong has gained a great share.
• Zong and Ufone were head to head in 3rd Quarter
last year – (Ufone is the 2nd largest company)

• All this data shows that the market is free, larger

number of sellers and buyers and all firms are
price takers.
 Example # 2
PAKISTAN DAIRY INDUSTRY

•Pakistan is 3rd largest producer in the world

•On average 33.6 Billion liters produced country
wide
•15-19% is wasted due to spoiling
•Total contribution to economy – Rs.540 Billion
•97% of the economic activity is non-
documented
•Most of the producers are mixed farmers while
very few are producing independently
Recommendations:
•More transactions should be well documented for
government to generate revenue
•Government in return can provide facilities and job
opportunities can be created
•Boosting productivity can reduce imports – and more
free market mechanism can be maintained
•More imports and lesser exports can increase job
opportunities
•Technological advances can create more jobs
•Lesser technological advances lead to spoiling of mik
•More technological advances can increase job and
investing opportunities
• Better factors of production and proper balance
between labor and machinery can not only increase
productivity but also increase other opportunities for
job and investment. Which includes:

• Animal caring
• Herd manager
• Equipment Contractor
• Equipment maintenance services
• Milkmen services
• Milk tank and storage services
• Barn construction services
• Animal feeding services