CHAPTER 12: PERFECT COMPETITION
1. What is Perfect Competition?
2. How perfect competition arises
3. Price takers
4. Economic Profit and Revenue, TR,MR & AR curves
5. The Firm’s Decision in Perfect Competition
6. ProfitMaximizing Output
7. Marginal Analysis
8. Profits and Losses in the Short Run
Three possible profit outcomes
9. The Firm’s ShortRun Supply Curve
10.ShortRun Industry Supply Curve
11.Output, Price and Profit in Perfect Competition in ShortRun
12.Output, Price and Profit in Perfect Competition in LongRun
13.Competition and Efficiency
Fiona Tasnim Rahman, Winter2011, ECON101 1 1.What is Perfect Competition?
Perfect competition is an industry in which
Many firms sell identical products to many buyers.
There are no restrictions to entry into the industry.
Established firms have no advantages over new ones.
Sellers and buyers are well informed about prices.
2.How Perfect Competition Arises
Perfect competition arises when firm’s minimum efficient scale is
small relative to market demand so there is room for many firms
in the industry.
And when each firm is perceived to produce a good or service
that has no unique characteristics, so consumers don’t care which
firm they buy from.
In perfect competition, each firm is a price taker.
No single firm can influence the price—it must “take” the
equilibrium market price.
Fiona Tasnim Rahman, Winter2011, ECON101 2 Each firm’s output is a perfect substitute for the output of the
other firms, so the demand for each firm’s output is perfectly
4. Economic Profit and Revenue
The goal of each firm is to maximize economic profit, which
equals total revenue minus total cost.
Total cost is the opportunity cost of production, which
includes normal profit.
A firm’s total revenue equals price, P, multiplied by quantity
sold, Q, which is P × Q.
A firm’s marginal revenue is the change in total revenue that
results from a one unit increase in the quantity sold. Because
in perfect competition the price remains the same as the
quantity sold changes, marginal revenue equals price.
Figure 12.1 illustrates a firm’s revenue concepts.
Part (a) shows that market demand and market supply determine the
market price that the firm must take.
Fiona Tasnim Rahman, Winter2011, ECON101 3 The demand for a firm’s product is perfectly elastic because one
firm’s sweater is a perfect substitute for the sweater of another
The market demand is not perfectly elastic because a sweater is a
substitute for some other good.
A perfectly competitive firm’s goal is to make maximum economic
profit, given the constraints it faces.
So the firm must decide:
1. How to produce at minimum cost
2. What quantity to produce
3. Whether to enter or exit a market
We start by looking at the firm’s output decision.
5.The Firm’s Output Decision
A perfectly competitive firm chooses the output that maximizes
its economic profit.
Fiona Tasnim Rahman, Winter2011, ECON101 4 One way to find the profitmaximizing output is to look at the
firm’s the total revenue and total cost curves.
Figure 12.2 looks at these curves along with the firm’s total profit
At low output levels, the firm incurs an economic loss—it can’t
cover its fixed costs.
At intermediate output levels, the firm makes an economic profit.
At high output levels, the firm again incurs an economic loss—
now the firm faces steeply rising costs because of diminishing
Fiona Tasnim Rahman, Winter2011, ECON101 5 The firm maximizes its economic profit when it produces 9
sweaters a day.
7.Marginal Analysis and Supply Decision
The firm can use marginal analysis to determine the profit
Because marginal revenue is constant and marginal cost
eventually increases as output increases, profit is maximized by
producing the output at which marginal revenue, MR, equals
marginal cost, MC.
Figure 12.3 shows the marginal analysis that determines the
If MR > MC, economic profit increases if output increases.