BUSS1040 Lecture 5 - Perfectly Competitive Markets

Characteristics of a market

• Concentration

  • number & size distribution of firms in market and market share

    • high concen - small no. of firms control large market share (telecomm, power)

    • low concen - large no. of firm and no firms have market power (food)

• Product differentiation

  • physical/subjective diffs in consumers minds between rival firm products

    • feature of a prod that sets it apart from other similar prods

    • homogenous vs differentiated products 

• Barriers to entry 

  • how difficult for new firm to enter market and compete w existing firms 

    • legal barriers (govt reg, patent rights etc)

    • nature (technical, costs, financial) 

Characteristics - Perfect comp

• large no of buyers and sellers

  • single seller has no impact on p by either prod more or less

• homogenous prod

  • each sellers prod is identical to its competitiors

• low barriers 

  • freedom of entry and exits by firms

• perfect info

  • p and quality of prod assumed to be known to all consu and prod

• perfect mobility of FOPs

• price takers

  • indv firms take the market price as given — cant exert influence on p

Basic market structures - Monopolistic comp

• many sellers (low concen)

• differentiated prods

• some barriers

Basic market structures - Oligopoly

• few sellers (high concen)

• homogenous or differentiated

• high barriers

Basic market structures - Monopoly

• one seller

• unique; no close substitute

• high barriers/blocked

Market D curve vs D curve for firm (coffee supplier)

Profit

Profit = TR - TC

TR

TR = P x Q

Average Rev

AR = TR/Q = (P x Q)/Q = P

Marginal Rev

MR = △TR/△Q

Perfect Comp D Curve

MR = △TR/△Q = (P x △Q)/△Q = P

Therefore, P = D = AR = MR

Firms Cost formulas

TC, AFC, AVC, ATC, MC

TC = TFC + TVC 

AFC = TFC/Q

AVC = TVC/Q

ATC = TC/Q

MC = △TC/△Q

Profit Max

Profit max occurs when MR = MC and MC cuts MR curve from below

Economic Profits SR

Profit = (P-ATC) x Q

• Econ profits

  • TR>TC or Profit>0

  • when P>ATC

• Remember — TC = explicit costs + implicit costs

Break-even/Normal Profit SR

Making a loss SR

How firm can minimise losses SR

• in SR — no firm will entry/exit 

• in SR — fixed costs will be incurred whether or not firm produces

• if P>AVC — firm still produces because at least some fixed costs are recovered 

• if P<AVC — firm will shut down as by producing - losses are bigger

Shut down point on SR Curve

Losses bigger than losses by not producing

Econ to Normal Profit — LR Eq

• firms can enter and exit freely in market 

• labour and capital perfectly mobile 

• if market eq p at P0 — firms will make economic profit — leads to entry of new firms into the market

• marks eq p lower (P1) — until firms only make normal profit 

  

Loss to Normal Profit - LR Eq

• if market eq is at P3 — losses 

• leads to exit of firms 

• makes eq p higher (P1) until firms make normal profit 

In Eq in the LR…

• firms can only make normal or zero economic profit 

• P = MR = MC = ATC (min of ATC since MC cuts ATC at min pt) 

  

External economies & diseconomies (LR indus s)

External economies

• factors beyond control of indv firm that lower costs as indus expands 

• e.g. as computer indus expands — cost of chips fall

External diseconomies 

• factors outside control of a firm that raises firm’s costs as indus ouput increases

• e.g. as wine indus expands — cost of water increases

Constant Cost Industry (Graph + Adjustment Process) 

SR

• Industry

  • D decreases (D1→D2) 

  • P rises (P1→P2) 

  • SR Eq at C 

• Firm 

  • Output increases (q1→q2) + rising MC 

LR 

• economic profit attracts new firms — Market supply curve shifts (S1→S2)

• Prices fall back to P1 w LR Eq at B 

• LR S curve is SL

Constant cost industry 

• entry and exit in LR ensures all firms earn zero profits and the price is P* = ATC_min

• assumes that all firms have access to same tech and same cost structure and does not change as indus grows

Increasing cost industry 

• upward sloping LR S curve 

• if potential entrants have a higher cost than incumbent firms (already in market) 

• some resources used in prod maybe available in limited qtys (input p rises as indus expands) — costs for all firms rise

• congestion may rise w indus output (e.g. airlines)

Increasing Cost Industry (Graph + Adjustment Process) 

SR

• Industry 

  • Increase in D (D1→D2) 

  • Increase in P (P1→P2) 

• Firm 

  • q1 to q2 by moving along MC1

LR

• Industry 

  • increase in profits cause new firms to enter indus 

  • shifts SR S curve (S1→S2) 

  • P falls back (P2→P3) 

  • as output expands — input p increases (AC1→AC2) 

  • economic profit eliminated — LR S curve is SL

Decreasing Cost Industry

• as output in indus expands — costs for all firms fall

  • if there are EOS in input markets

  • e.g. computer software — as market expanded — avg costs for all firms fall

• following increase in d — entry will continue till no longer profitable 

• new LR Eq p has to be lower than initial Eq

• LR indus s curve is downward sloping 

Decreasing Cost Industry (Graph + Adjustment Process) 

SR

• Industry 

  • increase in D (D1→D2) 

  • increase in P (P1→P2) 

  • Qty increases (Q2→Q2) 

• Firm 

  • q1→q2 along MC1 

LR 

• Industry

  • increase in profits cause new firms to enter 

  • shift in SR s curve (S1→s2) 

  • Qty increases (Q2→Q3) 

  • p falls back (P2→P3)

• output expands — input p falls — AC1→AC2

• economic profit eliminated 

• LR s curve is SL