market perfect

7/31/2019 Market Perfect

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Market:Perfect Competition



Agenda for discussionMarket structurePerfect CompetitionMarket Demand and Market SupplyThe Competitive Firm’s Demand Curve Equilibrium of the industry in the perfectcompetition

Equilibrium of the firm: Profit MaximizationThe Shutdown Point



Market structure

The characteristics of a market thatinfluence how trading takes place1. How many buyers and sellers?2. Products: standardized or significantly

different?3. Barriers to entry/exit ?



Market structure

Types of marketsPerfect competitionMonopolyMonopolistic competitionOligopoly



Perfect Competition:Characteristics

Many buyers and sellersno individual decision maker cansignificantly affect the price of the

productStandardized product

buyers do not perceive differencesbetween the products

Sellers can easily enter/exit themarket

no significant barriers to discourage newentrants



Perfect Competition:Characteristics

• Each firm attempts to maximizeprofits

• Each firm is a price takerits actions have no effect onthe market price

• Information is perfect• Transactions are costless



Market Demand curve of theIndustry

x xx

px px px

x1* x2*

p x*

To derive the market demand curve, we sum thequantities demanded at every price

x1

Individual 1’s demand curve

x2

Individual 2’s demand curve

Market demandcurve

X*

X

x1* + x2* = X*



Market Supply Curve of theindustry

quantity Quantityquantity

PPP

q 1A q 1

B

P 1

To derive the market supply curve, we sum thequantities supplied at every price

s A

Firm A’s supply curve s B

Firm B’s supply curve

Market supplycurve

Q1

S

q1A + q 1

B = Q 1



Equilibrium of Industry under perfectcompetition

Sl.No.

Price( in Rs.)

MarketDemand(Pen) = total of individualdemand

Market Supply(Pen) = totalof individualdemand

EquilibriumOrDisequilibrium

1 5 2500 400 Disequilibrium

2 10 2400 500 Disequilibrium3 15 2200 600 Disequilibrium



6 30 1500 1500 Equilibrium

7 35 1200 1800 Disequilibrium8 40 1000 2000 Disequilibrium







Perfect Competition

QuantityDemanded at

Different Prices

QuantitySupplied at

Different Prices

IndividualDemand

Curve

IndividualSupplyCurve

Quantity Demandedby All Consumers at

Different Prices

Quantity Supplied byAll Firms at Different

Prices

MarketDemand

Curve

MarketSupplyCurve

Quantity Suppliedby Each Firm

QuantityDemanded by

Each Consumer

P S D

Q

Market Equilibrium

Added together Added together



Equilibrium of the firm: Break even pointTotal Cost and Total Revenue

Total Revenue• The amount that the firm receives for the

sale of its output.

Total Cost• The amount that the firm pays to buyinputs.

Profit is the firm’s total revenue minus its totalcost.

Profit = Total revenue - Total cost



Equilibrium of the firm: Break even pointTotal Cost and Total Revenue

TR

550

2,800

1,950

TC

Slope = 400

Quantity

Price, TRAnd TC

1 2 3 4 5 6 7 8 9 10

Profit = TR-TCMaximum Profit

= 850Break Evenpoint A



The Competitive Firm’s DemandCurve

D

S

Output

Price Market Firm

Output

Price

400

1. The intersection of the market supplyand the market demand curve…

Rs400

3. The typical firm can sell all itwants at the market price…

2. determines theequilibrium market price

DemandCurve Facing

the Firm

4. so it faces a horizontaldemand curve.



Profit Maximization

Total Profit = TR – TCMR>MC – increase output

Maximize profit: MR=MCMeasuring Total Profit

Profit per unit = P – ATC

If P > ATC – the firm earns profitIf P < ATC – the firm suffers a loss



Equilibrium of firm under perfectcompetition

Firm attains equilibrium by maximizing profitProfit = Revenue – cost (∏ = R - C) …..(1)

R and C are functions of the level of output Q.So appropriate condition for max value of profit

d ∏/dq = 0 (necessary condition) d2 ∏ /dq 2 < 0 (sufficient condition)

From (1) above d ∏ /dq = d/dq (R - C) = 0= dR/dQ – dC/dQ = 0 …. i.e., MR – MC = 0 orMC = MR …………………(2)



Measuring Profit or Loss

Output

Price

1 2 3 4 5 6 7 8

MC

ATC

400d = MR

Total profit = profit per unit *Q

300

Profit per unit=revenue per unit - cost per unitProfit per unit (`Rs.100)

MR=MCQ=7



Measuring Economic Profit or Loss

MC

ATC

d = MR 300

200

Loss per unit= cost per unit - revenue per unitLoss per Unit(100)

Output

Price

1 2 3 4 5 6 7 8

MR=MCQ=5

Total loss = loss per unit *Q



The Firm’s Short -Run SupplyCurve

The firmtakes the market price as givendecides how much output to produce at

that priceProfit-maximizing output level: P=MC

As price of output changes, firm will slidealong its MC curve in deciding how much

to produce



Short-Run Equilibrium in Perfect Competition

400,000 700,000

2.00

3.50

S

D 1

D 2

MC

d 1

d 2

ATC

7,0004,000

2.00

3.50

3. If the demand curve shifts toD

2 and the market equilibrium

moves here . . .

2. the typical firm operates here, earningeconomic profit in the short run.

1. When the demand curve is D 1 andmarket equilibrium is here . . .

Profit per unit atp = 3.50

PriceMarket

Output

PriceFirm

Output

Loss per unit at p = 2

4. the typical firm operates here andsuffers a short-run loss.



Competitive Markets in theLong Run

New firms can enter the marketExisting firms can exit the market

Profit and loss in the long runEconomic profit - outsiders enter themarketEconomic losses - firms exit the market



From Short-Run Profit to Long-Run Equilibrium

S 1

d 1 ATC

MC

4.50

Profit attracts entry, shiftingthe supply curve rightward…

4.50

900,000 9,0005,000until market price falls toRs. 2.50 and each firmearns zero economicprofit.

S 2

d 2

A A

2.502.50EE

Market Firm

Price

Output

Price

Output

D

1,200,000



From SR Loss to LR EquilibriumEconomic losses - firms exit the marketMarket supply curve - shift leftwardMarket price - risesDemand curve facing each firm - shiftsupward

Economic loses – firms exit until

economic loss = 0In the LR, firms earn “normal profit” -zero economic profit



Perfect Competition and PlantSize

In LR equilibrium, every firm willselect

Plant sizeOutput level

AndOperate at minimum point of LRATCcurve



Perfect Competition and PlantSize

P 1

q 1

d 1 = MR 1

LRATC

MC 1 ATC 1

E

d 2 = MR 2

LRATC

MC 2 ATC 2

P*

q*

4. and all firms earn zero economicprofit and produce at minimumLRATC.

Price Price

OutputOutput

3. As all firms increase plant size andoutput, market price falls to its lowestpossible level . . .

1. With its current plant and ATC curvethe firm earns zero economic profit.

2. The firm could earn positive profit

with a larger plant, producing here



A Summary of the CompetitiveFirm in the LR

In long-run equilibrium, thecompetitive firm produces Q where:

MC=minimum ATC=minimumLRATC=P

Consumers are getting the best dealthey could possibly get

market perfect

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