the model of the perfect competition.ppt

the model of the perfect competition

1. The Model of Perfect Competition Dr Arifa Saeed

2. Perfect Competition - An Ideal Firms are primarily distinguished from each other by the degree of competition they face: Profit maximization. The Model of Perfect Competition. Allocative and Productive efficiencies. Long-run costs and adjustments Perfect Competition Monopoly Monopolistic Competition Oligopoly

3. Profit Maximizing Rule No matter what kind of firm we are talking about, they will max. profit when: Marginal Revenue = Marginal Cost (MR) (MC) If MR > MC, you are foregoing profit. If MR < MC, you are foregoing profit.

4. Perfect Competition All goods are identical . --One cannot be (usefully) distinguished from another. Many buyers and sellers. --No one can affect price through their actions. There are no barriers to entry/exit. --Firms cannot earn economic profit in the long run. Buyers & sellers have perfect information . --A single price will prevail in the market.

5. Perfect Competition Market price = price to the firm = MR (This is the “demand” for the firm’s output & is perfectly elastic.) MC q* Q Q e P e P S D $ P e = MR = d q A Firm The Market q 1 q 2

6. Perfect Competition How can we tell if a firm makes a profit? Calculate: Total Revenue = P • q* & Total Cost = ATC • q* Econ Profit = TR - TC $ MR = d q A Firm P e MC q* ATC

7. Scenario #1 - Positive Profit The ATC must be less than the price, so that calculated profit is positive. $ MR = d q A Firm P e MC q* ATC What will happen in this industry in the long run?

8. Scenario #2 - Zero Econ Profit The ATC must be equal to the price, so that calculated profit is zero. A Firm $ MR = d q P e MC q* ATC What will happen in this industry in the long run?

9. Scenario #3 - Negative Profit I The ATC must be more than the price, so that calculated profit is negative. What will happen in this industry in the long run? $ MR = d q A Firm P e MC q* ATC AVC Will this firm stay in business in the short run? It depends . . .

10. Scenario #3 - Negative Profit II: The Shutdown Point The firm will shut down, right away, if the Price (MR) is less than the AVC… or, if the total loss > fixed costs What will happen in this industry in the long run? $ MR = d q A Firm P e MC q* ATC AVC Fixed Costs Do worksheet on perfect competition.

11. Perfect Competition & Efficiency Allocative Efficiency (What to produce?) Productive Efficiency (How to produce?) occurs when Price = Marginal Cost Why ? occurs where output level is at the minimum ATC Why ?

12. Perfect Competition & Efficiency Perfectly competitive firms are always Allocatively Efficient Perfectly competitive firms always charge a price = MC. Why? $ MR = d q P e MC q* ATC In the LR, perfectly competitive firms produce at min. ATC. Why? In the LR, perfectly competitive firms are Productively Efficient

13. Perfect Competition in LR We know that in SR, firms can earn a positive, or negative, economic profit. What happens in the long run? Q Q e P e P S D The Market Q Q e P e P S D The Market If econ profits are positive, entry occurs S* If econ profits are negative, exit occurs S*

14. Perfect Competition in LR If a firm earns positive economic profit, in the long run that will be dissipated as firms enter. Q Q e P e P S D The Market $ MR = d q A Firm P e MC q* ATC S* MR* = d* P e * q* In the LR, this firm earns 0 econ profit.

15. Perfect Competition in LR If a firm earns negative economic profit, in the long run that will be eliminated as firms exit. Q Q e P e P S D The Market $ MR = d q A Firm P e MC q ATC In the LR, this firm earns 0 econ profit. q* MR* = d* P e * S*

16. The Paradox of Taxing Economic Profit In the short run, there are no consequences ! MC q Q Q e P e P S D* $ P e = MR = d q A Firm The Market D ATC q* P* MR* = d*