Perfect Competition

Econ 10

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DefinitionPerfect Competition is the Industry Structure characterized by •many, many firms•each firm has no independent effect on the market price (price taker)•homogeneous goods•perfectly elastic demand (for a particular firm’s good)

Common examples:produce stand

The demand for a particular firm’s good

Market(Tomatoes) S

D

d

Firm(Farmer Joe’s Tomatoes)

Qq

P$

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Costs

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Definition

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Perfect Competition:Generic Cost Curves

Q

$

AVC

ATC

MC

Perfect Competition:Condition I: P>ATC

Q

$

AVC

ATC

MC

D

Wheredoes P=MC?

Perfect Competition:Condition I: P>ATC

Q

$

AVC

ATC

MC

D

Perfect Competition:Condition I: P>ATC

Q

$

AVC

ATC

MC

DTR

TC

PROFIT

P>ATC==> ProfitP>AVC==> Stay Open

Perfect Competition:Condition II: AVC< P < ATC

Q

$

AVC

ATC

MC

DWheredoesP=MC?

Perfect Competition:Condition II: AVC< P < ATC

Q

$

AVC

ATC

MC

D

Perfect Competition:Condition II: AVC< P < ATC

Q

$

AVC

ATC

MC

D

LOSS

TVC

TFCTC

P<ATC==> LossP>AVC==> Stay Open

Perfect Competition:Condition III: P<AVC

Q

$

AVC

ATC

MC

D

WheredoesP=MC?

Perfect Competition:Condition III: P<AVC

Q

$

AVC

ATC

MC

D

WheredoesP=MC?

Perfect Competition:Condition III: P<AVC

Q

$

AVC

ATC

MC

D

TC

TVC

TFCLOSS if firmproduces

P<ATC==> LossP<AVC==> Better to close

Two ways to figure “I should shut down”

LOSSTFC )( TCTRTFC

TRTCTFC

TRTVCTFCTFC

TVCTR

Continue to operate if….

Road Map

Costs

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Definition

Tables

Tables

Remember when we did all those cost tables?MP TVC TC AVC ATC MC4 12 27 3 6.75 36 24 39 2.4 3.9 24 36 51 2.571429 3.642857 33 48 63 2.823529 3.705882 42 60 75 3.157895 3.947368 6

N Q1 42 103 144 175 19

W=$12, TFC=$15Now, in order to determine where the firm should operate, need to know... P=$4Where does P=MC?A: Q=17Profit = TR- TC = $4 * 17 - 63 = 68-63 = 5Firm should (obviously) not shut down.

TablesCondition I

MP TVC TC AVC ATC MC4 12 27 3 6.75 36 24 39 2.4 3.9 24 36 51 2.571429 3.642857 33 48 63 2.823529 3.705882 42 60 75 3.157895 3.947368 6

N Q1 42 103 144 175 19

W=$12, TFC=$15, P=$4Note that (indeed, just as we claimed) profit is maximized at P=MC. TR TC Profit

16 27 -1140 39 156 51 568 63 576 75 1

Why is here better than here?

Answer: normal profit/opp cost

Perfect Competition:Condition I: P>ATC

Q

$

AVC

ATC

MC

DTR

TC

PROFIT

P>ATC==> ProfitP>AVC==> Stay Open

TablesCondition II

MP TVC TC AVC ATC MC4 12 27 3 6.75 36 24 39 2.4 3.9 24 36 51 2.571429 3.642857 33 48 63 2.823529 3.705882 42 60 75 3.157895 3.947368 6

N Q1 42 103 144 175 19

W=$12, TFC=$15, P = $3

Profit is maximized at the largest Q where P=MC.TR TC Profit12 27 -1530 39 -942 51 -951 63 -1257 75 -18

Compare here and here (P=MC at both)

Suppose P = $3

P=MC at Q=14==> profit = 42 - 51 = -9 (loss of 9)but stay open (9<15)

Perfect Competition:Condition II: AVC< P < ATC

Q

$

AVC

ATC

MC

D

TC

TR

LOSS

P<ATC==> LossP>AVC==> Stay Open

TablesCondition IIIMP TVC TC AVC ATC MC4 12 27 3 6.75 36 24 39 2.4 3.9 24 36 51 2.571429 3.642857 33 48 63 2.823529 3.705882 42 60 75 3.157895 3.947368 6

N Q1 42 103 144 175 19

W=$12, TFC=$15, P = $2

Suppose P = $2

P=MC at Q=10==> profit = 20 - 39 = -19 (loss of 19)Now should close (19>15)

Note that1. Loss at Q>0 where P=MC > TFC2. TR<TVC

Perfect Competition:Condition III: P<AVC

Q

$

AVC

ATC

MC

D

TC

TR

LOSS

P<ATC==> LossP<AVC==> Better to close

Road Map

Costs

Graphs

Definition

Tables

Your TurnN Q1 32 73 104 125 13

Wage = $24, TFC = $60, P =$12

What is best Q>0? Profit/loss at this Q? Should firm shut down? Sketch the graph.

N Q1 52 153 304 405 45

Wage = $30, TFC=$60,P=$3

What if TFC = $110? What does this do to the best Q>0 and the shutdown decision?