Econ 300 PPT CH - 05-1

Understanding Economics
6th edition
by Mark Lovewell
Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.
6th edition
by Mark Lovewell
Chapter 5
Perfect Competition
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives
After this chapter you will be able to:
1. distinguish the four market structures, and the main
differences among them
2. understand the profit-maximizing rule and how
perfect competitors use it in the short run
3. identify how perfect competitive markets adjust in the
long run, and the benefits they provide to consumers

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

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

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

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.

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)

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

Attributes of Market Structures
Figure 5.1, Page 119
Perfect Monopolistic Oligopoly Monopoly

Competition Competition
Numbers of very many many few one

Businesses
Type of standard differentiated standard or not

Product differentiated applicable
Entry and Exit of very easy fairly easy difficult very

New Business difficult
Market Power none some some great
Example farming restaurants automobile public

manufacturing utilities

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

Perfect Competitors Demand (b)
Figure 5.2, page 121
Market Demand and Supply Pure n Simple T-Shirts
Curves for T-Shirts Demand Curve
Sm
Price ($ per T-Shirt)

6 6 Db
Dm
0 27 000 0
Quantity of T-Shirts per Day Quantity of T-Shirts per Day

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)

Revenue Conditions for a Perfect Competitor
Average revenue equals price, so that a perfect
competitors average revenue curve is its horizontal
demand curve.
A perfect competitors average revenue (price) is
constant so that marginal revenue and average revenue

are always equal.

Revenues for a Perfect Competitor
Revenue Schedules for Pure n Simple T-Shirts
Price Quantity Total Revenue Marginal Revenue Average Revenue

(P) (q) (TR) (MR) (AR)
($ per T-shirt) (T-Shirts per day) (P x q) (TR/q) (TR x q)
$-- $ 0 $ 0
480/80 = $6
6 80 480 480/80 = $6
720/120 = 6
6 200 1200 1200/200 = 6
300/50 = 6
6 250 1500 1500/250 = 6
120/20 = 6
6 270 1620 1620/270 = 6
60/10 = 6
6 280 1680 1680/280 = 6
Revenue Curves for Pure n Simple T-Shirts

$ per T-Shirt
6 Db = AR = MR
0
Quantity of T-Shirts per Day

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 revenue

Profit Maximization for a Perfect Competitor
Profit Maximization Table for Pure n Simple T-Shirts
Total Price Marginal Marginal Average Average Total Total Total
Product (P) Revenue Cost Variable Cost Cost Revenue Cost Profit
(q) (=AR) (MR) (MC) (AVC) (AC) (TR) (TC) (TR - TC)
(TC/q) (VC/q) (TC/q)
0 $6 $ 0 $ 825 $-825
$6 $1.75
80 6 $1.75 $12.06 480 965 -485
6 1.33
200 6 1.50 5.63 1200 1125 75
6 2.50
250 6 1.70 5.00 1500 1250 250
6 5.50
270 6 1.98 5.04 1620 1360 260
6 10.50
280 6 2.29 5.24 1680 1465 215
Profit Maximization Graph for Pure n Simple T-Shirts

MC
a
6.00 Db = MR = AR
Profit = $260 AC
5.04 b
$ per T-Shirt
AVC
0 270

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.

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.

Supply Curve for a Perfect Competitor
Supply Curve for Pure n Simple T-Shirts

Supply Schedule for
Pure n Simple T-Shirts MC(=Sb)
Price Quantity a MR1
(P) Supplied 6.00
AC
(q) 5.00
$ per T-Shirt
($ per T-Shirt (T-Shirts per day) b MR2
$6.00 270
AVC
5.00 250
1.50 200 c
1.50
1.40 0 d
1.40
0 200 250 270


Supply Curves for a Perfectly Competitive Business and
Market
Figure 5.6, page 127 Business and Market Supply Schedules for T-Shirts
Price Quantity Supplied
(P) (q) (Q)
(Sb) (Sm)
($ per T-Shirt) (T-Shirts per day)
$6.00 270 27 000
5.00 250 25 000
1.50 200 20 000
Supply Curve for Supply Curve for T-Shirt Market

Pure n Simply T-Shirts
Sb Sm

6.00 6.00
5.00 5.00
1.50 1.50
0 200 250 270 0

20 000 25 000 27 000

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 supply shifts left and price rises.

Long-Run Equilibrium for a Perfectly Competitive
Business
Pure n Simply T-Shirts T-Shirt Market
MC S0
AC
$ per T-Shirt
$ per T-Shirt
S1
b d
6 6
a
5 5 e
MR c
D1
D0
0 250 270 0
25 000 27 000 30 000

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)

How Resource Markets Operate
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.

The Determinants of 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

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

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.

Labour Demand and Supply for a Product and Resource Price-Taker
Figure A
Labour Demand and Supply Schedules for a Strawberry Farm
Labour Total Product Marginal Product Output Price Total Marginal Marginal
(L) (P) (MP) (P) Revenue Revenue Resource Cost
(no. of (q) (q/L) (TR) Product (MRC = W)
workers) (kilograms) (kilograms) ($ per kilogram) (P x q) (MRP = TR) ($ per hour)
0 0 $2 $0
10 $20 (a) $10
1 10 2 20
8 16 (b) 10
2 18 2 36
6 12 (c) 10
3 24 2 48 > (d)
4 8 (e) 10
4 28 2 56
2 4 (f) 10
5 30 2 60
Labour Demand and Supply Curves for a Strawberry Farm
20
Wage ($ per hour)
a
16
b
12
c
MRC = Sb
8 d
e
4
f MRP = Db
0 1 2 3 4 5
No. of Workers

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

Demand and Supply in a Competitive Labour Market
Figure B
Labour Demand and Supply Curves

Labour Demand and Supply Schedules for Strawberry Farm Workers
for Strawberry Farm Workers
SM
Wage Labour Demanded Labour 18
(W) (DM) Supplied
($ per (SM) 14
Wage ($ per hour)

hour) (no. of (no. of (no. of
workers) workers) workers)
(farm) (market) 10 e
(market)
$18 1 1000 5000
6
14 2 2000 4000
10 3 3000 3000
2
6 4 4000 2000 DM
2 5 5000 1000
0 1000 2000 3000 4000 5000
No. of Workers

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, because one investment project differs
from another.

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

Resource Demand (OLC)
A Product Price-Maker/ Resource Price-Taker (a)
If a business is a price-maker in its product market and
a price-taker in its resource market, then:
the resources marginal cost is constant
the resources marginal product varies
the marginal revenue of the new units of output falls as
quantity rises

A Product Price-Maker/ Resource Price-Taker (b)
Just as in the case of a business that is a price-taker in
its product market, the profit-maximizing rule also
applies in this case of a product price-maker.
In other words, the business should use a resource up
to the point where its marginal revenue product and its

marginal revenue cost intersect.

Labour Demand and Supply for a Product Price-Maker/Resource Price Taker Figure
A
Labour Demand and Supply Curves

Labour Demand and Supply Schedules for Nirvana Cushions
for Nirvana Cushions
32 g
Labour Total Marginal Output Total Marginal Marginal
(L) Product Product Price Revenue Revenue Resource
Wage ($ per hour)

(no. of (P) (MP) (P) (TR) Product Cost
workers) (q) (q/L) (P x q) (MRP = (MRC = W)
(no. of (no. of TR/ L) ($ per hour)
cushions) cushions)
h
0 0
4
$10 $0
$32 (g) $7
10 i MRC = Sb
1 4 8 32 7
3 10 (h) 7 j
2 7 6 42 > (i) 3
2 3 (j) 7
3 9 5 45 0
1 -5 (k) 7
4 10 4 40 -5 1 2 3 k4 5
MRP = Db
No. of Workers

Market Demand and Supply
If the resource market this business is
operating in is competitive, the degree of
competition in the product does not affect
how market demand in the resource market
is determined.
As before (as shown in the text appendix),
the resource demand curves of all businesses

are combined to find the market demand
curve.

Changes in Resource Demand (a)
There are three main resource demand
factors: product prices, resource prices, and
technological change.
Resource demand is affected by changes in
product prices. For example, a rise in a

product price causes the MRP for relevant
resources to rise, shifting demand for these
resources to the right.

Changes in Resource Demand (b)
To identify the effect of other resources
prices, we must distinguish two types of
resource combinations.
Complementary resources are used together
(e.g. steam shovels and steam-shovel
operators). The price for one of these
resources and the demand for the other have
an inverse relationship. For example, a drop in
the price of steam shovels increases the
demand for steam shovel operators.

Changes in Resource Demand (c)
Substitute resource are used in place of one
another (e.g. steam shovels and manual
labour). The price for one of these resources
and the demand for the other have a direct
relationship. For example, a drop in the price
of steam shovels decreases the demand for
manual labour.

Changes in Resource Demand (d)
Technological innovation has two possible
effects. If a new or more productive type of
machine is introduced, for example,
complementary resources will increase in
demand, while demand for substitute
resources will decrease.

A Measure of Justice (OLC) (a)
The ancient philosopher Aristotle:

stated that trade should be based on an equality of
proportion between the two items being exchanged
was the first to point out the potential injustices caused
by monopoly power

A Measure of Justice (OLC) (b)
Aristotle distinguished two types of value:

Use value relates to a goods intrinsic characteristics.
Exchange value relates to how much a good can fetch in
return for other goods.

Aristotle saw these values as distinct, based on the so-
called paradox of value, whereby some rare goods such
as gold are worth more than useful goods such as iron.

A Measure of Justice (OLC) (c)
According to Aristotle and his followers (both

historical and present-day), a overemphasis on the
exchange values of products diminishes our ability to
recognize real worth.

6th edition
by Mark Lovewell
Chapter 5
The End
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

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Understanding Economics

Copyright 2012 by McGraw-Hill Ryerson

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barriers) provides a product with no close substitutes.

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Perfect Monopolistic Oligopoly Monopoly

Numbers of very many many few one

Type of standard differentiated standard or not

Entry and Exit of very easy fairly easy difficult very

Market Power none some some great

Example farming restaurants automobile public

Copyright 2012 by McGraw-Hill Ryerson

prevailing market price.

Copyright 2012 by McGraw-Hill Ryerson

Price ($ per T-Shirt)

Quantity of T-Shirts per Day Quantity of T-Shirts per Day

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

constant so that marginal revenue and average revenue

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Price Quantity Total Revenue Marginal Revenue Average Revenue

Revenue Curves for Pure n Simple T-Shirts

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Copyright 2012 by McGraw-Hill Ryerson

Profit Maximization Graph for Pure n Simple T-Shirts

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adding the supply curves for all the businesses in the

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Supply Curve for Pure n Simple T-Shirts

0 200 250 270

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Supply Curve for Supply Curve for T-Shirt Market

Price ($ per T-Shirt)

0 200 250 270 0

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Copyright 2012 by McGraw-Hill Ryerson

Pure n Simply T-Shirts T-Shirt Market

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use resources based on how much extra profit each of

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Labour Demand and Supply Curves for a Strawberry Farm

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Labour Demand and Supply Curves

Wage ($ per hour)

0 1000 2000 3000 4000 5000

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to the point where its marginal revenue product and its

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Labour Demand and Supply Curves