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Chapter 5
Competitive Markets
The perfectly competitive firm
- Assumptions:
1. All firms and consumers are price takers.
2. Buyers and sellers have perfect information.
3. Products are Homogenous.
4. Free entry and exit.
5. There are N. of firms.
Competitive firms demand curve
The shape of the demand curve facing a price – taking firm is different from the market demand curve.
The demand curve is flat and the flatness of the curve indicates that a small price rise will chock off demand (perfect elastic). On the other hand there is no need to lower the price because the competitive firm can sell as much as it wants at the market price.
Competitive firm's output decision
As we mentioned earlier the firm can sell as much as it wants at the market price so it will expand it's output as long as the extra benefits of doing so exceed the extra cost, that is until MR = MC
The profit Maximizing output
For given market price, the firm should produce the level of output at which MC = MR or MC = P since MR = P
At Q2-=->MC MR -=-> reducing output to maximize
At Q1-=->MR MC -=-> increasing output to maximize
At Qe-=-> MR = MC -=-> profit maximized
The supply curve of the perfectly competitive firm
Under the perfect competition the firm producer where P = MC
This picture shows the - Max output quantities
Q1 and Q2 for a perfectly competitive firm facing two different market price level P1 and P2 when the price goes up from P1 to P2 the firm will supply more since the - Max output has been risen, and so this increase in output from Q1 to Q2 determined by the shape of the MC
Short-Run Supply
The short run supply curve of the perfectly competitive firm is that part of the short-run MR curve above the short run average variable cost (SRAVC) curve.
Notice the following
- SRAC = TC
Output Q
SRAVC: is the variable cost per unit at each level of output.
- The firm supply curve is the Bold part from SRMC curve.
- At Q1 the price is P2 where MR=MC, this price covers SRAVC, but it's not enough to cover SRAC, so the firm therefore making loser since it's not covering the distance A-B from the total cost which is fixed cost part.
Should the firm choose to produce Q1 or will it prefer not to produce at all?
In short-run as long as price is above AVC the firm is better of continuing to produce.
LOOK BACK TO EXERSICE 5.2 PAGE 130
Long-run Supply
In long-run all the cost are variable or No fixed cost.
The Long Run Marginal Cost LRMC and the Long Run Average Cost LRAC
Are flatter than the short run curve, because the cost can be reduced in the log run by adjusting capacity as output rises or falls toward the lowest point on the average cost curve (Point A)
The firm will produce where P=LRMC provided that price is not below LRAC so the LR supply curve of the firm is that part of LRMC which is above the minimum AC [Bold Part]
The perfectly competitive industry
The perfectly competitive industry consists of a large number of price taking firms, each supplies only a small part of the total industry supply and is hence unable individually to influences the market price.
Market Equilibrium
A: Individual demand curve
B: Quantity demanded and supplied in the market as a whole
C: Firms supply
We can get the total market demand curve by horizontally adding the individual demand and the same for industry supply by horizontally adding the firms supply.
Monopoly and perfect competition compared
Suppose there is one producer in the market at the beginning, and then the government deregulate the industry allowing new entrants.
Monopolist / Competitor
Optimal level / MC = MR / MC = MR
Output / Qm / Qc
Price / Pm / Pc
/ (Pm-AC)Qm = shaded area / (Pc-AC)Qc = Zero
Consumer satisfaction / Worse of / Better off
Example if price is 7 and
Q / TC / TR / MC / MR0 / 12 / 0 / - / -
1 / 17 / 7 / 5 / 7
2 / 20 / 14 / 3 / 7
3 / 21 / 21 / 1 / 7
4 / 24 / 28 / 3 / 7
5 / 29 / 35 / 5 / 7
6 / 36 / 42 / 7 / 7
7 / 45 / 49 / 9 / 7
8 / 56 / 56 / 11 / 7
TR = PQ
MR = TR
Q
The demand level of output where MR=MC at Q = 6, so
= TR – TC
= 42 – 36 = 6
OR
= (P – AC) Q
= (1 – 36) 6 = 6
6
Note that column(1) and (2) are given while others are calculated
1
Good Luck.:LuLu:.