Perfect Competition

1. Perfect Competition

2. Demand for the product of a perfectly competitive firm • Price determined by S & D • Price taker • Won’t charge higher or lower than market price • Horizontal (perfectly elastic) at market price.

3. Market demand Individual firm

4. MR = AR = P

6. The equilibrium of the firm under any conditions Firms aim to maximise profit Two rules for profit-maximisation • shut-down rule • profit maximising rule

7. The shut-down rule The shut-down rule: a firm should produce only if total revenue is equal to, or greater than, total variable cost (which includes normal profit).

8. Profit maximising rule Profit is maximised where marginal revenue (MR) is equal to marginal cost (MC). In summary… • When MR > MC, output should be expanded • When MR = MC, profits are maximised • When MR < MC, output should be reduced

9. Equilibrium in terms of total revenue and total cost

10. POINT a: MR (R10) – MC (R4) = R6 POINT c: MR (R10) – MC (R8) = R2 POINT e: MR (R10) – MC (R12) = -R2 POINT b: MR (R10) – MC (R6) = R4 POINT d: MR (R10) – MC (R10) = R0 Equilibrium in terms of marginal revenue and marginal cost

11. Check these out… Profit Maximising Level Perfect Competition

12. Normal profits Normal profits: occur when total costs = total revenue. Minimum earnings required to prevent entrepreneur leaving and applying factors of production elsewhere.

13. At Q2, AR = P2 = AC(C2) This occurs at Q2 Normalprofit earned, since all its costs, including self-employed resources, are fully covered. E2 aka break even point As AR = AC, the firm does not earn an economic profit. Profit is maximised where MR = MC = P2

14. TR = P2 X Q2 = 0P2E2Q2 TC = C2 X Q2 = 0C2E2Q2 0C2E2Q2 (TC) =0P2E2Q2 (TR) Can also be found by TR - TC

15. Economic profits Economic profits: profit that a business makes that is more than the normal profit. Economic profit occurs when total revenue > total costs. AKAexcess profit, abnormal profit, supernormal profit or pure profit.

16. Economic profit earned – above breakeven point. At Q3, AR (P3) > AC (C1) At Q3, AR = P3 and AC = C1 This occurs at Q3 Profit is maximised where MR = MC = P3

17. TC = C1 X Q3 = 0C1MQ3 0P3E3Q3 (TR) >0C1MQ3 (TC) Difference = Economic Profit = C1P1E3M TR = P3 X Q3 = 0P3E3Q3 Can also be found by TR - TC

18. Economic loss Economic loss: occurs when a firm makes less than normal profit. • I.e. price (AR) < AC

19. This occurs at Q3 Economic loss = C3 – P3 At Q3, AR (P3) < AC (C3) At Q3, AR = P3 and AC = C3 Profit is maximised where MR = MC = P3

20. 0P3E3Q3 (TR) <0C1MQ3 (TC) Difference = Economic Loss = P3C3ME3 TC = C3 X Q3 = 0C3MQ3 TR = P3 X Q3 = 0P3E3Q3 Can also be found by TR - TC

21. If a firm is making an economic loss, should they leave the market? Depends on average revenue (P) relative to average VARIABLE costs. If P < AVC, best to leave the industry.

22. Movement to a long term equilibrium

23. Movement to a long term equilibrium

24. Allocative Efficiency Allocative efficiency: a situation where it is impossible to reallocate the resources to make at least one person better off without making someone else worse off. Allocative inefficiency: it is possible to make at least one person better off without making someone else worse off. In such a case the welfare of society can be improved by reallocating the resources.

25. Society’s welfare maximised when… P (OC of consuming extra unit) = MC (OC of producing extra unit) Are perfectly competitive firms allocatively efficient? • P = MR • Profit maximisation at MR = MC • Therefore they produce at P = MR = MC

26. Productive efficiency Productive efficiency: occurs when all the firms in the industry produce where their long-runaverage or unit costs are at a minimum. When this occurs – no waste of scarce resources. Perfectly competitive firms inequilibrium in the long run where average cost is at a minimum – thus productively efficient.