market perfect
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Market:Perfect Competition
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Agenda for discussionMarket structurePerfect CompetitionMarket Demand and Market SupplyThe Competitive Firm’s Demand Curve Equilibrium of the industry in the perfectcompetition
Equilibrium of the firm: Profit MaximizationThe Shutdown Point
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Market structure
The characteristics of a market thatinfluence how trading takes place1. How many buyers and sellers?2. Products: standardized or significantly
different?3. Barriers to entry/exit ?
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Market structure
Types of marketsPerfect competitionMonopolyMonopolistic competitionOligopoly
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Perfect Competition:Characteristics
Many buyers and sellersno individual decision maker cansignificantly affect the price of the
productStandardized product
buyers do not perceive differencesbetween the products
Sellers can easily enter/exit themarket
no significant barriers to discourage newentrants
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Perfect Competition:Characteristics
• Each firm attempts to maximizeprofits
• Each firm is a price takerits actions have no effect onthe market price
• Information is perfect• Transactions are costless
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Market Demand curve of theIndustry
x xx
px px px
x1* x2*
p x*
To derive the market demand curve, we sum thequantities demanded at every price
x1
Individual 1’s demand curve
x2
Individual 2’s demand curve
Market demandcurve
X*
X
x1* + x2* = X*
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Market Supply Curve of theindustry
quantity Quantityquantity
PPP
q 1A q 1
B
P 1
To derive the market supply curve, we sum thequantities supplied at every price
s A
Firm A’s supply curve s B
Firm B’s supply curve
Market supplycurve
Q1
S
q1A + q 1
B = Q 1
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Equilibrium of Industry under perfectcompetition
Sl.No.
Price( in Rs.)
MarketDemand(Pen) = total of individualdemand
Market Supply(Pen) = totalof individualdemand
EquilibriumOrDisequilibrium
1 5 2500 400 Disequilibrium
2 10 2400 500 Disequilibrium3 15 2200 600 Disequilibrium
4 20 2000 1000 Disequilibrium
5 25 1800 1300 Disequilibrium
6 30 1500 1500 Equilibrium
7 35 1200 1800 Disequilibrium8 40 1000 2000 Disequilibrium
9 45 800 2500 Disequilibrium
10 50 500 2800 Disequilibrium
11 55 400 3000 Disequilibrium
12 60 100 3500 Disequilibrium
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Perfect Competition
QuantityDemanded at
Different Prices
QuantitySupplied at
Different Prices
IndividualDemand
Curve
IndividualSupplyCurve
Quantity Demandedby All Consumers at
Different Prices
Quantity Supplied byAll Firms at Different
Prices
MarketDemand
Curve
MarketSupplyCurve
Quantity Suppliedby Each Firm
QuantityDemanded by
Each Consumer
P S D
Q
Market Equilibrium
Added together Added together
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Equilibrium of the firm: Break even pointTotal Cost and Total Revenue
Total Revenue• The amount that the firm receives for the
sale of its output.
Total Cost• The amount that the firm pays to buyinputs.
Profit is the firm’s total revenue minus its totalcost.
Profit = Total revenue - Total cost
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Equilibrium of the firm: Break even pointTotal Cost and Total Revenue
TR
550
2,800
1,950
TC
Slope = 400
Quantity
Price, TRAnd TC
1 2 3 4 5 6 7 8 9 10
Profit = TR-TCMaximum Profit
= 850Break Evenpoint A
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The Competitive Firm’s DemandCurve
D
S
Output
Price Market Firm
Output
Price
400
1. The intersection of the market supplyand the market demand curve…
Rs400
3. The typical firm can sell all itwants at the market price…
2. determines theequilibrium market price
DemandCurve Facing
the Firm
4. so it faces a horizontaldemand curve.
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Profit Maximization
Total Profit = TR – TCMR>MC – increase output
Maximize profit: MR=MCMeasuring Total Profit
Profit per unit = P – ATC
If P > ATC – the firm earns profitIf P < ATC – the firm suffers a loss
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Equilibrium of firm under perfectcompetition
Firm attains equilibrium by maximizing profitProfit = Revenue – cost (∏ = R - C) …..(1)
R and C are functions of the level of output Q.So appropriate condition for max value of profit
d ∏/dq = 0 (necessary condition) d2 ∏ /dq 2 < 0 (sufficient condition)
From (1) above d ∏ /dq = d/dq (R - C) = 0= dR/dQ – dC/dQ = 0 …. i.e., MR – MC = 0 orMC = MR …………………(2)
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Measuring Profit or Loss
Output
Price
1 2 3 4 5 6 7 8
MC
ATC
400d = MR
Total profit = profit per unit *Q
300
Profit per unit=revenue per unit - cost per unitProfit per unit (`Rs.100)
MR=MCQ=7
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Measuring Economic Profit or Loss
MC
ATC
d = MR 300
200
Loss per unit= cost per unit - revenue per unitLoss per Unit(100)
Output
Price
1 2 3 4 5 6 7 8
MR=MCQ=5
Total loss = loss per unit *Q
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The Firm’s Short -Run SupplyCurve
The firmtakes the market price as givendecides how much output to produce at
that priceProfit-maximizing output level: P=MC
As price of output changes, firm will slidealong its MC curve in deciding how much
to produce
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Short-Run Equilibrium in Perfect Competition
400,000 700,000
2.00
3.50
S
D 1
D 2
MC
d 1
d 2
ATC
7,0004,000
2.00
3.50
3. If the demand curve shifts toD
2 and the market equilibrium
moves here . . .
2. the typical firm operates here, earningeconomic profit in the short run.
1. When the demand curve is D 1 andmarket equilibrium is here . . .
Profit per unit atp = 3.50
PriceMarket
Output
PriceFirm
Output
Loss per unit at p = 2
4. the typical firm operates here andsuffers a short-run loss.
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Competitive Markets in theLong Run
New firms can enter the marketExisting firms can exit the market
Profit and loss in the long runEconomic profit - outsiders enter themarketEconomic losses - firms exit the market
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From Short-Run Profit to Long-Run Equilibrium
S 1
d 1 ATC
MC
4.50
Profit attracts entry, shiftingthe supply curve rightward…
4.50
900,000 9,0005,000until market price falls toRs. 2.50 and each firmearns zero economicprofit.
S 2
d 2
A A
2.502.50EE
Market Firm
Price
Output
Price
Output
D
1,200,000
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From SR Loss to LR EquilibriumEconomic losses - firms exit the marketMarket supply curve - shift leftwardMarket price - risesDemand curve facing each firm - shiftsupward
Economic loses – firms exit until
economic loss = 0In the LR, firms earn “normal profit” -zero economic profit
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Perfect Competition and PlantSize
In LR equilibrium, every firm willselect
Plant sizeOutput level
AndOperate at minimum point of LRATCcurve
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Perfect Competition and PlantSize
P 1
q 1
d 1 = MR 1
LRATC
MC 1 ATC 1
E
d 2 = MR 2
LRATC
MC 2 ATC 2
P*
q*
4. and all firms earn zero economicprofit and produce at minimumLRATC.
Price Price
OutputOutput
3. As all firms increase plant size andoutput, market price falls to its lowestpossible level . . .
1. With its current plant and ATC curvethe firm earns zero economic profit.
2. The firm could earn positive profit
with a larger plant, producing here
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A Summary of the CompetitiveFirm in the LR
In long-run equilibrium, thecompetitive firm produces Q where:
MC=minimum ATC=minimumLRATC=P
Consumers are getting the best dealthey could possibly get
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