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Understanding Perfect Competition: Costs, Conditions, and Market Dynamics

This guide covers the essential concepts of perfect competition in economics. Perfect competition is characterized by numerous firms selling homogeneous goods, where each firm is a price taker with perfectly elastic demand. We explore the conditions for profitability (where price exceeds average total cost), the implications of losses, and decision-making related to shutting down operations. Detailed graphs and tables illustrate cost curves, market scenarios, and give practical examples using production data to demonstrate optimal output levels and shutdown conditions.

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Understanding Perfect Competition: Costs, Conditions, and Market Dynamics

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  1. Perfect Competition Econ 10 Holmes

  2. Road Map Costs Definition Graphs Tables

  3. Definition • Perfect 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

  4. The demand for a particular firm’s good Market (Tomatoes) Firm (Farmer Joe’s Tomatoes) $ P S d D q Q

  5. Road Map Costs Definition Graphs Tables

  6. Perfect Competition:Generic Cost Curves MC $ ATC AVC Q

  7. Perfect Competition:Condition I: P>ATC MC $ ATC D AVC Where does P=MC? Q

  8. Perfect Competition:Condition I: P>ATC MC $ ATC D AVC Q

  9. Perfect Competition:Condition I: P>ATC PROFIT MC $ ATC D TR AVC TC P>ATC==> Profit P>AVC==> Stay Open Q

  10. Perfect Competition:Condition II: AVC< P < ATC MC $ ATC AVC D Where does P=MC? Q

  11. Perfect Competition:Condition II: AVC< P < ATC MC $ ATC AVC D Q

  12. Perfect Competition:Condition II: AVC< P < ATC LOSS MC $ ATC AVC D TFC TC TVC P<ATC==> Loss P>AVC==> Stay Open Q

  13. Perfect Competition:Condition III: P<AVC MC $ ATC AVC Where does P=MC? D Q

  14. Perfect Competition:Condition III: P<AVC MC $ ATC AVC Where does P=MC? D Q

  15. Perfect Competition:Condition III: P<AVC MC $ ATC AVC TFC TC LOSS if firm produces D TVC P<ATC==> Loss P<AVC==> Better to close Q

  16. Two ways to figure “I should shut down” Continue to operate if….

  17. Road Map Costs Definition Graphs Tables

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

  19. TablesCondition I W=$12, TFC=$15, P=$4 Note that (indeed, just as we claimed) profit is maximized at P=MC. Why is here better than here? Answer: normal profit/opp cost

  20. Perfect Competition:Condition I: P>ATC PROFIT MC $ ATC D TR AVC TC P>ATC==> Profit P>AVC==> Stay Open Q

  21. TablesCondition II Suppose P = $3 W=$12, TFC=$15, P = $3 P=MC at Q=14==> profit = 42 - 51 = -9 (loss of 9) but stay open (9<15) Profit is maximized at the largest Q where P=MC. Compare here and here (P=MC at both)

  22. Perfect Competition:Condition II: AVC< P < ATC LOSS MC $ ATC TC AVC D TR P<ATC==> Loss P>AVC==> Stay Open Q

  23. TablesCondition III Suppose P = $2 W=$12, TFC=$15, P = $2 P=MC at Q=10==> profit = 20 - 39 = -19 (loss of 19) Now should close (19>15) Note that 1. Loss at Q>0 where P=MC > TFC 2. TR<TVC

  24. Perfect Competition:Condition III: P<AVC LOSS MC $ ATC AVC TC D TR P<ATC==> Loss P<AVC==> Better to close Q

  25. Road Map Costs Definition Graphs Tables

  26. Your Turn Wage = $30, TFC=$60, P=$3 Wage = $24, TFC = $60, P =$12 What is best Q>0? Profit/loss at this Q? Should firm shut down? Sketch the graph. What if TFC = $110? What does this do to the best Q>0 and the shutdown decision?

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