Perfect Competition

1
Perfect Competition

• Market structure in the output market.
• Number of firms
• Type of product
• Ease of entry/exit
• Market info and knowledge
• Price and output are strongly related to market
  structure.

2
Perfect Competition

• Homogeneous or standardized product
• Enough firms so that each firm is small relative
  to the market. Thus, no control over price.
• No obstacles to entry and exit.
• Perfect info about product and market. Best
  method of production market price. Also
  potential entrants know whether existing firms
  earn economic profits.

3
Firms Demand and Perfect Competition

• Since each firm is a price-taker, its demand
  curve is horizontal at the market price. It can
  also said to be perfectly elastic at the market
  price.

P
S
P
D
P
P
D
Q
Q
Firm
Market
4
Firms Demand

• The firms demand curve in perfect competition is
  also the
• MR curve since each additional unit adds a
  constant amount (Price) to Total revenue(TR)
• Average Revenue curve since AR is TR/Q

5
Profit Maximization in the Short Run
MC

DMRP
MRMC
Q
Q
Remember FC is irrelevant in the Short Run. Old
MBMC Rule for Unconstrained Max from Chap. 4
6
Short Run Equilibrium for the Perfectly
Competitive Firm

• There are actually two basic cases to be
  considered
• Revenues (TR) covers variable costs(TVC). In
  this case the firm produces where MRMC
• If PgtATC, operate at economic profit
• If min AVC gtPltATC operate at a loss(but will
  minimize loss)
• Revenues(TR) is not able to cover variable
  cost(TVC) at any level of output(Q). In this
  case the firm should shut down (Q0). This
  occurs when Plt min AVC.

7
Graphics for Previous Slide

• Refer to Figure 12.4, 12.5, and 12.6 in text plus
  lecture drawings.
• Note Figure 12.6 covers all possibilities by
  assuming 3 different market prices(P1, P2, P3)

8
Short Run Supply in Perfect Competition

• The short run supply curve for the firm is that
  part of the MC curve above AVC. (Figure 12.7)

MC

AVC
Q
9
Long Run Equilibrium in Perfect Competition

• In the LR, firms can freely enter and exit the
  industry in response to market incentives.
• Thus, if economic profits exist new firms will be
  attracted into the industry. As the number of
  firms increase, market Supply increases and
  market price falls. As market price falls so
  goes each firms demand curve (since price
  takers) and the process continues til all
  economic profit is eliminated.

10
Long Run Equilibrium in Perfect Competition

• See graphics in lecture and Figures 12.8 and
  12.9.
• LR equilibrium occurs when

P LMCLAC
11
Rent and Long Run Supply

• Economic rent is the payment to the owner of a
  resource in excess of the resources opportunity
  cost.
• Firms that employ such productive resources earn
  only normal profits in the LR because the excess
  is paid to the owner of the resource.
• Shaq receives huge rents since his income is far
  in excess of his opportunity costs.

12
Profit Maximizing Input Usage

• So far have focused on profit max in terms of the
  output to produce.
• Need to also develop profit max in terms of input
  usage.
• Again this is an application of unconstrained
  maximizing theory in which the solution is MB
  MC. We just change names to fit the application.
• MB increase in revenue generated by hiring an
  additional unit of labor (will call MRP)
• MC increase in cost due to hiring an additional
  unit of labor (is the wage rate)

13
Marginal Revenue Product

• The marginal revenue product (MRP) is the
  additional revenue earned when the firm hires an
  additional unit of labor.

I units of the input MR marginal revenue MP
marginal product
14
14, page 472
MRP MR(MP)
MC w/MP
L Q MP MRP PL w MC Profit
1 5 5 10 10 2 -50
2 15 10 20 10 1 -40
3 30 15 30 10 0.67 -20
4 50 20 40 10 0.50 10
5 65 15 30 10 0.67 30
6 77 12 24 10 0.83 44
7 86 9 18 10 1.11 52
8 94 8 16 10 1.25 58
9 98 4 8 10 2.50 56
10 96 -2 -4 10 ------ 42
FC50