2015 by McGraw-Hill Ryerson Ltd.

Chapter 5
Perfect Competition

2015 by McGraw-Hill Ryerson Ltd.

Learning Objectives
After this chapter you will be
able to:

identify the four market

structures and the main
differences among them
describe the profit-maximizing
output rule and explain how
perfect competitors use it in the
short run
2015 by McGraw-Hill Ryerson Ltd.

Market Structures
There are four main market
structures:
perfect competition
monopolistic competition
oligopoly
monopoly

2015 by McGraw-Hill Ryerson Ltd.

Perfect Competition
Perfectly competitive markets
have three main features:
many buyers and sellers
a standard product
easy entry and exit

2015 by McGraw-Hill Ryerson Ltd.

Monopolistic Competition
Monopolistically competitive
markets have three main
features:
many buyers and sellers
slightly different products
easy entry and exit

2015 by McGraw-Hill Ryerson Ltd.

Oligopoly and Monopoly

In an oligopoly a few
businesses (protected by
entry barriers) provide
standard or similar products.
In a monopoly a single
business (protected by entry
barriers) provides a product
with no close substitutes.

2015 by McGraw-Hill Ryerson Ltd.

Entry Barriers
There are six main entry barriers in
oligopolies and monopolies:
increasing returns to scale
market experience
restricted ownership of resources
legal obstacles (such as patents)
market abuses (such as predatory pricing)
advertising (which is most common in
oligopolies)

2015 by McGraw-Hill Ryerson Ltd.

Market Power
Market power:
is a businesss ability to affect
the price it charges
varies with market structure,
such that monopolists have
the most and perfect
competitors have the least

2015 by McGraw-Hill Ryerson Ltd.

Attributes of Market Structures

FIGURE 5.1

Numbers of
Businesses
Type of
Product

Perfect
Competitio
n

Monopolisti
c
Competition

very many

many

standard

Entry and Exit of

New Business

differentiated

very easy

fairly easy

none

some

farming

restaurants

Market Power
Example

2015 by McGraw-Hill Ryerson Ltd.

Oligopoly

Monopoly

few

one

standard or
differentiated

not
applicable

difficult

very
difficult

some

great

automobile
manufacturin
g

public
utilities

10

Perfect Competitors
Demand
A perfect competitor has a
demand curve different from the
market demand curve.
The businesss demand curve is
horizontal at the prevailing
market price.

2015 by McGraw-Hill Ryerson Ltd.

11

Perfect Competitors Demand

FIGURE 5.2
Pure n Simple T-Shirts
Demand Curve
Sm

Dm
0

27 000

Quantity of T-Shirts per Day

2015 by McGraw-Hill Ryerson Ltd.

Price ($ per T-Shirt)

Price ($ per T-Shirt)

Market Demand and Supply

Curves for T-Shirts

Db

0
Quantity of T-Shirts per Day

12

Average and Marginal

Revenue
Total revenue is used to find
two other revenue concepts:
average revenue (total
revenue divided by output)
marginal revenue (change in
total revenue divided by
change in output)

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13

Revenues for a Perfect

Competitor

Average revenue equals

price, so that a perfect
competitors average
revenue curve is its
horizontal demand curve.

Because average revenue

(price) has a constant value,
marginal revenue and average
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14

Revenues
for aCompetitor
Perfect
venues for a Perfect
Competitor FIGURE 5.3
Figure 5.3, page 122

Revenue Schedules for Pure n Simple T-Shirts

$-6
6
6
6
6

Total Revenue Marginal Revenue

(TR)
(MR)
(P x q)
(TR/q)

Quantity
(q)
(T-Shirts per day)
$ 0
80
200
250
270
280

0
480
1200
1500
1620
1680

Average Revenue
(AR)
(TR x q)

480/80 = $6
720/120 = 6
300/50 = 6
120/20 = 6
60/10 = 6

480/80 = $6
1200/200 = 6
1500/250 = 6
1620/270 = 6
1680/280 = 6

Revenue Curves for Pure n Simple T-Shirts

$ per T-Shirt

Price
(P)
($ per T-shirt)

Db = AR = MR

0
Quantity of T-Shirts per Day

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15

The Profit-Maximizing
Output Rule
The profit-maximizing output rule
states that profit is maximized
when marginal revenue equals
marginal cost. This means:
output should be increased if
marginal revenue exceeds
marginal cost
output should be decreased if
marginal cost exceeds marginal

2015 by McGraw-Hill Ryerson Ltd.

16

Profit Maximization for a for

Perfect
Profit-Maximization
a Perfect
Competitor
Competitor
FIGURE 5.4
Figure 5.4, page 124
Profit Maximization Table for Pure n Simple T-Shirts

Total
Product
(q)

Price
(P)
(=AR)

0
80
200
250
270
280

$6
6
6
6
6
6

Marginal
Revenue
(MR)

Marginal
Average
Cost
Variable Cost
(MC)
(AVC)
(TC/q)
(VC/q)

$
6
6
6
6
6

$1.75
1.33
2.50
5.50
10.50

Average
Cost
(AC)
(TC/q)

Total
Revenue
(TR)
$

$1.75
1.50
1.70
1.98
2.29

$12.06
5.63
5.00
5.04
5.24

0
480
1200
1500
1620
1680

Total
Cost
(TC)
$ 825
965
1125
1250
1360
1465

Total
Profit
(TR - TC)
$825
-485
75
250
260
215

Profit Maximization Graph for Pure n Simple T-Shirts

MC
6.00

a
Profit = $260

5.04

Db = MR = AR

AC

$ per T-Shirt

AVC

270
Quantity of T-Shirts per Day

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17

The Breakeven and

Shutdown Points
The breakeven point is where a business
breaks even while maximizing profit.

For a perfect competitor this occurs where

price equals minimum average cost.

The shutdown point is the lowest price at

which a business will choose to operate
in the short run.

It occurs where price equals minimum

average variable cost
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18

A Perfect Competitors
Supply Curve
A perfect competitors supply
curve is its marginal cost curve
above the shutdown point.
The market supply curve can be
found by horizontally adding the
supply curves for all the
businesses in the industry.

2015 by McGraw-Hill Ryerson Ltd.

19

Perfect Competitors Supply

Curve FIGURE 5.5
Supply Curve for Pure n Simple T-Shirts
Supply Schedule for
Pure n Simple T-Shirts

$6.00
5.00
1.50
1.40

270
250
200
0

6.00
$ per T-Shirt

Quantity
Supplied
(q)
($ per T-Shirt (T-Shirts per day)

MC(=Sb)

Price
(P)

5.00

MR1
AC
MR2

AVC

1.50
1.40

c
d

200
Quantity of T-Shirts per Day

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20

250 270

Supply Curves for a Perfectly Competitive

Business and Market FIGURE 5.6
Business and Market Supply Schedules for T-Shirts
Price
(P)

Quantity Supplied
(q)
(Q)
(Sb)
(Sm)
(T-Shirts per day)

($ per T-Shirt)
$6.00
5.00
1.50

270
250
200

Supply Curve for T-Shirt Market

Sb

6.00
5.00

1.50

200

Price ($ per T-Shirt)

Price ($ per T-Shirt)

Supply Curve for

Pure n Simply T-Shirts

27 000
25 000
20 000

250270

Quantity of T-Shirts per Day

2015 by McGraw-Hill Ryerson Ltd.

Sm
6.00
5.00

1.50

20 000 25 000 27 000

Quantity of T-Shirts per Day

21

Perfect Competition in the

Long Run
Entry and exit by businesses in
the long run drives a perfectly
competitive market to the
breakeven point.
Businesses enter markets where
economic profits are made so that
supply shifts right and price falls.
Businesses leave markets where
economic losses are made so that

2015 by McGraw-Hill Ryerson Ltd.

22

Long-Run Equilibrium for a Perfectly

Competitive Business FIGURE 5.7
Pure n Simply T-Shirts

T-Shirt Market

MC

S0

6
5

MR1

MR0

$ per T-Shirt

$ per T-Shirt

AC
S1

d
6
5

D1
D0

250 270

Quantity of T-Shirts per Day

2015 by McGraw-Hill Ryerson Ltd.

25 000 27 000 30 000

Quantity of T-Shirts per Day

23

The Benefits of Perfect

Competition
Perfectly competitive markets in
long-run equilibrium meet two
conditions that benefit
consumers:
minimum-cost pricing (price =
minimum average cost)
marginal-cost pricing (price =
marginal cost)

2015 by McGraw-Hill Ryerson Ltd.

24

Marginal Productivity
Theory
The demand for resources is based
on the demand for the products
that these resources are used to
produce.
According to marginal productivity
theory, businesses use resources
based on how much extra profit
each of these resources provides.

2015 by McGraw-Hill Ryerson Ltd.

25

The Determinants of
Resource Demand
Three factors are important in
determining the demand for a
resource:
a resources marginal cost
a resources marginal product
the marginal revenue of new
units of output

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26

A Product and Resource

Price-Taker
If a business is a price-taker in its
product and resource markets:
the resources marginal cost is
constant
the resources marginal product is
variable
the marginal revenue of new units
of output is constant

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27

The Profit-Maximizing
Employment Rule
The profit-maximizing employment rule
states that profits are maximized when
marginal revenue product equals
marginal resource cost.
Marginal revenue product is the change in
total revenue when employing a new unit of
a resource.
Marginal resource cost is the change in total
cost when employing a new unit of a
resource.

2015 by McGraw-Hill Ryerson Ltd.

28

Labour Demand and Supply for a

Product and Resource Price-Taker

FIGURE A

Labour Demand and Supply Schedules for a Strawberry Farm

0
1
2
3
4
5

Total
Product
(P)
(q)
(kilograms)
0
10
18
24
28
30

Marginal
Product
(MP)
(q/L)
(kilograms)
10
8
6
4
2

Output Price
(P)

20
16

$2
2
2
2
2
2

a
b

12

MRC = Sb

4
0

Marginal
Marginal
Revenue
Resource
Product
Cost
(MRP = TR) (MRC = W)
($ per hour)
$0
$20
$1
20
(a)
0
36
16
10
> (d)
48
(b)
10
56
12 (c)
10
60
8
10
Strawberry Farm(e)
4 (f)

Total
Revenue
(TR)
($ per kilogram) (P x q)

Labour Demand and Supply Curves for a

Wage ($ per hour)

Labour
(L)
(no. of
workers)

f
1

MRP = Db
5

No. of Workers

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29

Market Demand and

Supply
In a competitive labour market:
the market demand curve is found by
horizontally summing the labour
demand curves for all businesses in
the industry
the market supply curve shows the
total number of workers offering their
services in this industry at each wage

2015 by McGraw-Hill Ryerson Ltd.

30

Demand and Supply in a

Competitive Labour Market

Labour Demand and Supply Curves

for Strawberry Farm Workers

Labour Demand and Supply Schedules

for Strawberry Farm Workers

$1
8
14
10
6
2

Labour
Demanded
(DM)
(no. of
(no. of
workers
workers
)
)
(farm)
(market
1
1000
)
2
2000
3
3000
4
4000
5
5000

Labour
Supplied
(SM)
(no. of
workers)
(market)
5000
4000
3000
2000
1000

SM

18

Wage ($ per hour)

Wage
(W)
($ per
hour)

FIGURE B

14

10
6
2

DM
1000 2000 3000 4000 5000

No. of Workers

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31

Demand for Other

Resources
Marginal productivity theory is
not always applicable to other
resources.
The theory can be employed for
labour and for natural resources,
because these resources are
measured in standardized units.
It is harder to calculate marginal
revenue product for capital goods,

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32

Can Capitalism Survive?

Joseph Schumpeter:
believed that entrepreneurs are the
driving force of economic progress in
capitalism
predicted that capitalism was
doomed because of the growing
dominance of government
bureaucracy antagonistic to
capitalism

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