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Define a perfectly competitive market, and explain why a perfect competitor faces a horizontal demand curve.
A perfectly competitive market has many buyers and sellers, all firms sell identical products and there are no barriers to new firms entering the market.
A perfectly competitive firm faces a horizontal demand curve because if the firm tried to raise its price, consumers would buy from the firm’s competitors.
Since the firm can sell all the output it wants at the current market price there would be no point to trying to charge a lower price.
If a firm increases the output it sells, the price will not decrease because each firm is too small to shift the market supply curve enough to lower equilibrium price.
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Explain how a perfect competitor decides how much to produce
To make profit as large as possible, a firm will produce that quantity of output for which marginal revenue equals marginal cost (MR = MC).
Since marginal revenue equals price for a perfectly competitive firm, price will also equal marginal cost at the profit maximising quantity of output (MR = P = MC).
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Explain how perfect competition leads to economic efficiency?
In the long run, competitive forces will drive the market price to the minimum average total cost of the typical firm. This means that perfect competition results in productive efficiency.
Firms also produce at the point where the marginal cost of producing another unit equals the marginal benefit consumers receive from consuming that unit. This means that perfect competition achieves allocative efficiency.
* This result only applies to perfectly competitive firms because only a horizontal demand curve can touch the long run ATC curve at its lowest point. Downward sloping demand curves will always be tangent to LRATC at a point above the minimum.
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Illustrating Profit or Loss on the Cost Curve Graph
Profit equals total revenue (TR) minus total cost (TC).
Since TR equals price multiplied by quantity sold (P x Q), this can be written as:
- Profit = (P x Q) - TC
- This equation means that profit per unit (or average profit) equals price minus average total cost
- Divide both sides by Q:
- Profit/Q = (P x Q)/Q - TC/Q
*TC/Q = ATC
Therefore: - Profit = (P - ATC) x Q
- Total Profit = (P - ATC) x Q
- Profit per unit of output = P - ATC
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To maximise profit, which of the following should a firm attempt to do?
To maximise profits, a perfectly competitive firm should produce that quantity of wheat where the difference between the total revenue he receives and his total cost is as large as possible.
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Profit per unit
Profit per unit equals price minus average total cost, or the distance between points A and B on the graph
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One of the curves in this figure is not necessary in order to determine the amount of profit obtained from producing any level of output. Which curve can be discarded?
Marginal cost is not needed in the computation of profit.
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What happens at point A?
The firm earns normal profit, or an amount of profit equal to the opportunity cost of remaining in this business for the business owner.
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Profits are maximised at Q2, where Marginal Revenue equals to Marginal Costs.
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How to calculate Total Cost?
Total Cost = Average Total Cost x Quantity
TC = ATC x Q
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A firm makes profit if:
P > ATC
&
Profit = (P - ATC) x Q
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A firm makes a loss if:
P < ATC
&
Loss = (ATP - P) x Q
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A Long Run Supply curve in a Perfectly competitive market is:
Equal to the minimum point on the typical firm's average total cost curve.
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Demand for a product within a firm in a perfectly competitve market is:
Horizontal:
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REMEMBER!!
In a perfectly competitive market,
Demand Curve = Marginal Revenue Curve
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Are perfectly competitive markets productively efficient in the long run?
Yes, because firms produce at the lowest average cost possible.
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To break even, firms have to produce the quantity that occurs at the
lowest average cost
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If a market is perfectly competitive, to maximise profits, a firm has to produce
at the point that the MC curve intersects the price curve.
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