The Perfectly Competitive

Market
Economics 11
UPLB
 Market Economy
the market is a system where buyers and sellers
exchange goods or services
market is actually a very logical mechanism that
helps answer the basic economic questions of
what, how much and for whom to produce
different commodities.
system continually allocates goods and services
to various units with the help of a pricing
mechanism
 The Market System
a market for commodities - rice, milk, water,
coffee, clothes and many others.
a market for the inputs used in the production
of these commodities like steel, minerals and
labor.
Each market may have a different structure:
the number of sellers or buyers
demand for the commodity
control in the market.
 Two General Types of Markets
I. the Perfectly Competitive Market [5 main
features]
II. the imperfect market
Monopoly one firm
Oligopoly two or more, but few firms
Monopolistic competition many firms selling
differentiated products.
 5 Features of Perfectly Competitive Market

1. Smallness of buyers and sellers relative to the

market
2. Homogeneous product
3. Absence of artificial restraints or controls
4. Perfect mobility of goods and resources
5. Perfect information
 The Demand Curve Faced by the Firm

since the firm cannot control the market price,

owing to its smallness relative to the market, the
firm can actually sell as much output as it wants
without influencing the price.
the firm in perfect competition faces a perfectly
elastic demand curve P

the equilibrium price is still determined in the

market by the forces of demand and supply
 Revenues of the Firm
Total revenue (TR) is the firm's gross income from the sale of its
product
TR=P.Q

Marginal revenue (MR) is the additional revenue earned from

each additional unit of output sold.

MR=TR/Q

Average revenue (AR) is total revenue divided by output.

AR=TR/Q
 Market Firm

Price
D S

P* P* d

0 0
Q Q
Equilibrium price is determined Once determined, a firm can sell as
in the market much as it wants at that price
 Market Firm

Price D2
D S

P2 P2 d2
P* P* d

0 0
Q Q
Equilibrium price is determined Once determined, a firm can sell as
in the market much as it wants at that price
 P P

Supply
Price

Price
P* P*

Demand

Q Q
0 0
Output Output

(A) Market (B) Firm

FIGURE 6.1. The market and firm demand curves for a perfectly competitive good.
In the left panel of this diagram, we find a downward sloping market demand curve for
the good. Its intersection with the market supply curve determines the equilibrium price
(P*) that will prevail in the market. Since a perfectly competitive firm can sell all that it
wants at P*, the firms demand curve is the horizontal line shown at the right panel of this
diagram.
 Price, MR and AR
Q P TR MR AR
0 200 0 - -
1 200 200 200 200
2 200 400 200 200
3 200 600 200 200
4 200 800 200 200
5 200 1000 200 200

Under pure competition, P = MR = AR

 Revenue

TR
600

400

P = 200 MR = AR

Q
0 1 2 3
Output
Total Cost, Total Revenue, and Profit at Different Levels of Output
Marginal
Output Price Total Revenue Revenue Total Cost Marginal Cost Profit
(Q) (P) (TR) (MR) (TC) (MC) ()
0 200 0 ~ 500 ~ -500
1 200 200 200 591 91 -391
2 200 400 200 668 77 -268
3 200 600 200 737 69 -137
4 200 800 200 804 67 -4
5 200 1000 200 875 71 125
6 200 1,200 200 956 81 244
7 200 1,400 200 1,053 97 347
8 200 1,600 200 1,172 119 428
9 200 1,800 200 1,319 147 481
10 200 2,000 200 1,519 200 481
11 200 2,200 200 1,784 265 416
12 200 2,400 200 2,119 335 281
13 200 2,600 200 2,529 410 71
14 200 2,800 200 3,019 490 -291
15 200 3,000 200 3,599 580 -599
 Profit Total Revenue, Total Cost

0
TR,TC

Q0

Output
Q*
Q1
TC

TR

Q
Q
Deriving profits from the TR and TC curves
Top panel
Profits or losses are measured by the vertical distance between the TR
and TC curves. For quantities between Q0 and Q1, the TR curve is above
the TC curve. For these levels of output, the firms profits are positive.
The TR and TC curves intersect at output levels Q0 and Q1. This means
that the firms profits at these levels of output are zero since TR=TC.
For output levels to the left of Q0 and to the right of Q1, the TR curve is
below the TC curve, which implies that the profits are negative.
Bottom Panel -
a bell-shaped profit curve.
firms profits are highest at Q* where the slope of the TR curve (MR) and
the slope of the TC curve (TC) are equal. Hence, Q* is the firms profit-
maximizing level of output.
 MC

P* A
Price, Revenue and Cost

200 MR = AR
AC
profit
C B AVC
150

E
100 D

Q
Q*
0
Output

Total Revenue TR = 0P*AQ*,

Total Cost TC = 0CBQ*,
Profit = CP*AB
 Profit maximization for a perfectly
competitive firm
The firm maximizes its profit at the intersection of the MR and
MC curves (point A) This means that the firms profit-
maximizing level of output is equal to Q*.
How large is the firms profit?
The firms total revenue is equal to the product of the price (line segment
0P*) and its output (line segment 0Q*). This suggests that its total
revenue is equal to the area 0P*AQ*.
On the other hand, the firms total cost is equal to the product of its
average cost at Q* (line segment 0C) and its output (line segment 0Q*).
This means that total cost is equal to the area 0CBQ*.
Since profit is equal to TR less TC, it is therefore equal to the difference
between areas 0P*AQ* and 0CBQ*. In other words, the firms profit is
equal to CP*AB
 EFFECT OF A FALL IN PRICE FROM P1 TO P2

MC

P1
Price, Revenue and Cost

AC
P2 AVC P2= MR2= AR2
profit

Q
Q2 Q2
0 * *
Output
 The effects of a fall in the output price
Since profit maximization requires the equality
between MR and MC, the fall in the price leads
to a fall in the firms output from Q1 to Q2 .
Profit also decreases
 IF PRICE FALLS TO P3 WHERE P=AC

MC
Price, Revenue and Cost

AC

AVC

P3 P3= MR3= AR3

Q
Q3
0 *
Output

At P3, P=AC, so TR=TC,

profit is zero
 Break even point
When price falls down to P3 , price equals the
lowest point of the firms average cost curve.
This means that the firms total cost and total
revenue are equal
Thus, the firms profit at P3 is equal to zero. We
refer to this as the break-even point.
 PRICE falls below AC at P4

MC
Price, Revenue and Cost

AC

AVC

C B
loss
P4 P4= MR4= AR4
A

E D

Q
Q4 Output
0 *

If price falls below AC at P4. The firm incurs a loss but must
continue to produce to minimize losses.
Loss Minimization at a price between the minimum
AC and AVC curves

If the output price (such as P4) is between the

minimum points of the AC and AVC curves, MR =
MC at point A, and the best output level is equal to
Q4.
The firm is experiencing losses at P4. TR<TC
implying a loss of P4 CBA.
To minimize its losses, the firm will continue to
produce. If the firm decides to stop production, it
will still continue to pay for its fixed costs ECBD
Since area ECBD is larger than P2CBA, its losses
from closing down are larger than its losses from
continued production.
 At P5 = min AVC, the loss is equal to the Total Fixed
Cost (TFC), which is the also the loss if the firm did
not produce. Therefore the firm should shut down.

MC
Price, Revenue and Cost

AC

AVC

loss

P5 P5= MR5= AR5

Q
Q 5*
0
Output
 Note that Q changes as P changes. Given the P, Q is
determined at P=MC. There for the MC curve traces the
firms supply curve, but only above the minimum AVC

MC
Price, Revenue and Cost

P1
AC
P2 AVC

P3

P4
P5

Q
Q5 Q4 Q3 Q2 Q1
0
Output
 Firms Supply Curve:
Portion of MC curve above MC
the AVC curve
Price, Revenue and Cost

P1
AC
P2 AVC

P3
loss
P4
P5 P= MR= AR

Q
Q5 Q4 Q3 Q2 Q1
0
Output
 Long Run Equilibrium
Suppose that the price level (determined by D-S)
is such that it is profitable for firms to operate.
Positive profits will attract new firms into the
industry.
Supply curve will shift to the right

Price will decline until profit is driven down to zero.

 Long Run Equilibrium
Suppose that the price level (as determined by
D-S conditions) is such that it not profitable for
firms to operate.
Negative profits will make some firms leave the
industry.
Supply curve will shift to the left

Price will increase until profit is no longer negative.

 P

D
S0

MC S1
SAC LAC

P0 MR, AR P0

P1 P1

Q1 Q0

At Po, firms are reaping profits. New The entry or exit of firms will stop
firms are attracted as long as profits only when profit is reduced to
are positive. Supply curve shifts to zero. This is at the lowest point of
the right, so price falls. the LAC curve.
 COST LMC

LAC

SMC1
SAC1

P MR, AR

0 Q

Long Run Equilibrium of the Industry: P = LMC = SMC, P = LAC = SAC

 Constant cost industry
Suppose that the industrys initial long-run equilibrium
corresponds to price and output levels P0 and Q0,
respectively.
With an increase demand from D0 to D1 short-run
equilibrium price and quantity increase
The higher price makes the industry profitable. Firms
will be encouraged to enter the industry. This causes a
rightward shift in the market supply curve.
We have a constant cost industry if the shift in the
supply curve leads to a long-run equilibrium wherein
the market price goes back to P0.
 P
D0 D1 S0 S1

P1

P0 Long Run Supply Curve

Price

Q
Q0 Q1

Quantity
COST LMC

LAC

SMC1
SAC1
P1 MR1

P0 MR0

0 Q

The increase in price will make the industry profitable. This will result
in entry of new firms. The increased supply will drive the price down
until profits are back to zero at P0.
 Increasing cost industry
Suppose that the industrys initial long-run equilibrium
corresponds to price and output levels P0 and Q0,
respectively.
With an increase demand from D0 to D1 short-run
equilibrium price and quantity increase.
The higher price makes the industry profitable. Firms
will be encouraged to enter the industry. The entry of
firms causes LAC to shift upwards.
We have a increasing cost industry if the shift in the
supply curve leads to a long-run equilibrium wherein
the market price P1 is greater than P0.
COST LMC

LAC1

LAC0

SMC1
P1 SAC1

P1 MR1
P0 MR0

0 Q0 Q1 Q

The increase in price will make the industry profitable. The entry of
new firms causes the LAC to increase (move up). Equilibrium will be
established at P1,Q1
 P
S1
D0 D1 S0

Long Run Supply Curve

P1
P1 P1
P0
Price

Q
Q0 Q1

Quantity

INCREASING COST INDUSTRY

 Decreasing cost industry
Industrys initial long-run equilibrium corresponds to
price and output levels P0 and Q0, respectively.
An increase demand from D0 to D1 results in higher
equilibrium price and quantity.
The higher price makes the industry profitable. Firms
will be encouraged to enter the industry. However, the
entry of firms causes LAC to shift downwards.
We have a decreasing cost industry if the shift in the
supply curve leads to a long-run equilibrium wherein
the market price P1 is less than P0.
COST

LAC0

LAC1

SMC1
P1 SAC1

P0 MR1
P1 MR0

0 Q1 Q0 Q

The initial increase in price will make the industry profitable.

However, the entry of new firms will cause the LAC to decrease (shift
downward). Equilibrium will be established at P1,Q1
 P
D0 D1 S0 S1

P1

P0
Price

P1
Long Run Supply Curve

Q
Q0 Q1

Quantity

DECREASING COST INDUSTRY

 Letter from parents to son
Dear Anak,
Naipadala ko na 50 thousand pesos na tuition fee
mo, pinagbili na namin ang
mga kalabaw natin. Ang mahal pala ng kursong
COUNTER STRIKE,
Wala na din pala tayong baboy naibenta na din
para dun sa sinasabi mo na project nyo na NOKIA
N75, ang mahal naman ng project nayun.
Kasama din ang 7 thousand dun para sa field trip
nyo sa MALL OF ASIA, anak malayo ba yun?
mag ingat ka sa pagbibiyahe mo,
 Letter from parents to son
Isasanla palang namin ang palayan natin para mabili mo
na yung instrumentong I-POD na kinakailangan mo sa
laboratory nyo.
Anak komportable kaba dyan sa boarding house mo san ba
kamu yan sa VICTORIA COURT ??? - maganda ba dyan?
Presco ba hangin katulad dito sa atin?
Anak kamusta na pala yung sayans group project nyo na
SANMIG LIGHT?
Napailaw nyo na ba? Mataas ba nakuha nyo na grado dun?
Anak sana bago pa maubos ang lahat lahat ng ari arian
natin ay makagradweyt ka na, walong taon ba talaga ang
kurso mo sa SECRETARIAL? ?? Sanapag gradweyt mo
makakuha ka ng trabaho kaagad kagaya ng manager ng
kumpanyapara mabawi natin ang mga ari arian nating
nasa sanglaan.
 Letter from parents to son
Ay sya nga pala anak diba sabi mo sa JOLLIBEE / MAK
DONALD ka palagi kumakain ok ba naman sayo ang
mga ulam dyan? Baka hindi masarap kawawa ka naman.

Anak hanggang dito na lang at sa susunod ay ipapadala

ko sayo ang pera na pambili mo ng ALTIS na gagamitin
mo sa VACANT SUBJECT mo.

Ang nagmamahal
Itang at Inang
P.S. Anak mag aral ka ng mabuti. Mahal na mahal ka
namin at gagawin namin ang lahat alang-alang sa iyo.