3.

10301

FOUNDATION
ECONOMICS

TOPIC 6 : FIRM BEHAVIOUR:

PERFECT
COMPETITION

Introduction
This unit begins our explanation of the price and
output decisions of firms. This depends on costs
and the market form in which they exist.
This unit analyses the firms decisions in the
context of a purely competitive industry.

The impact of the purely competitive industry on

the firms revenue is now introduced. Firms in this
type of market structure are price takers.

This means that price and output decisions in

pure competition will differ from those in other
market structures.

Perfect Competition Defined

A market is said to be perfectly competitive if
(1) there is a great number of buyers and
sellers of the commodity, so that actions of
an individual cannot affect the price of the
commodity,
(2) homogenous products of all firms in the
market,
(3) perfect mobility of resources,
(4) consumers, resource owners and firms in
the market have perfect knowledge of
present and future prices and costs

Perfect Competition Defined

The price of a commodity is determined exclusively

by the intersection of the market demand curve and
the market supply curve for the commodity. A
perfectly competitive firm is a price taker and can
sell any amount of the commodity at the
established price.

SR equilibrium of firm: Total

Approach
= TR TC
Therefore profit is maximised when
the positive difference between TR
and TC is the greatest. Hence
equilibrium output of firm is output at
which total profits are maximized. An
illustration is given in Table and
Figure on the next slide

P (K)

TR
(K)

TC (K)

Total Profit
(K)

800

-800

100

800

2,000

-1,200

200

1600

2,300

-700

300

2400

2,400

400

3200

2,524

+676

500

400

2,775

+1,225

600

4,800

3,200

+1,600

650

5,200

3,510

+1,690

700

5,600

4,000

+1,600

800

6,400

6,400

SR Equilibrium of firm:
Marginal Approach
In general it is more useful to analyse the SR
equilibrium of the firm with the (marginal revenue)
MR MC approach. MR is the change in TR (TR)
for a one unit change in the quantity sold.
Therefore MR is the slope of TR curve. In perfect
competition, price (P) is constant for the firm so
that MR = P.
The marginal approach tells us that the perfectly
competitive firm maximizes its SR profits at an
output level where MR or P = MC and MC is rising.
An illustration is given by the Table and the figure
TC 1200
on the next slide.

12.00
Q
100

MC =

P = MR
(K)

MC (K)

AC (K)

/UNIT
(K)

s(K
)

100

12.00

20.00

-12.00

-1,200

200

3.00

11.50

-3.50

-700

300

1.00

8.00

400

1.25

6.31

+1.69

+676

500

2.50

5.55

+2.45

+1,22
5

600

4.25

5.33

+2.67

+1,60
2

*65

(8.00)

5.40

+2.60

+1,69
0

700

8.00

5.71

+2.29

+1,60
3

800

24.00

8.00

SR profit or loss?
If, at the best or optimum level of
output price exceed average cost
(P>AC), firm is said to be maximizing
total profits.
If P<AC but >AVC firm is to be
minimizing total losses.
If P<AVC, firm is said to be minimising
total losses by shutting down (see
figure and table on the next slide.

nt = any output
R TC and at
P, therefore
to ATC

SR profit or loss?

Eq
Pt

P (K)

AC
(K)

/unit
(K)

Total
s
(K)

Result

max

d4

600

19

15.0
0

4.00

2,400

d3

500

14

14.0
0

d2

400

10

15.0
0

-5.00

-2,00

Total
min

losses

d1

300

16.3
3

-9.33

-2,800

Shut
point

down

Break-even
point

SR supply curve
We show from the MC curve in previous
Figure how much the firm will produce and
sell at various prices, the firms SR supply
curve is given by the rising portion of its
MC curve (over and above its AVC curve).
If factor prices are constant, the
competitive industry SR supply curve is
obtained by summing horizontally the
short run marginal cost (SMC) curves of all
firms in the industry.

SR supply curve

Industry equilibrium in
SR
For industry, the
demand curve is
downward sloping.
Why? If firms act
collectively at the
same time to expand
output, industry output
will increase. In order
to induce customers to
buy additional goods
on the market, price of
good must full.

Industry and firm

equilibrium in LR

In the long run there will be:

(1) Free entry and exit (no barriers to entry)
because of the presence of profits.
(2) In LR firm can change its plant size and other
changes.
Firms with identical costs.
The LR equilibrium is where
P = MC = AC =
LAC. In the LR firm will earn zero economic profit

LR Equilibrium Equation
e.g. Suppose given following
equation
demand
P = 23-Q
TC
TC = 3Q2
+ 7Q + 12
TR = P.Q
= (23 - Q) Q = 23
Q Q2
= TR TC
= 23Q - Q2 (3Q2 + 7Q
+ 12)
= 23Q Q2 3Q2 - 7Q
12
= -4Q2 + 16Q 12

To maximise profit
differentiate
d
- 8Q160
dQ

-8Q = 16
Q =2
P = 23-2
= K21
= -4 (2)2 + 16 (2)
12
= -16 + 32 12
= 4

LR Equilibrium Equation
2nd approach
= TR TC

= 23Q Q2 (3Q2+ 7Q + 12)

= MR MC

= (23 2Q) (6Q + 7)

maximised where

MR = MC

23-2Q = 6Q + 7

- 8Q = -16

Q=2