Chapter 12 - Perfect Competition

Perfect competition is a market structure comprised of many relatively small firms that produce virtually the same product and no firm is large enough to have any control over prices.

In perfect competition, firms are "price takers," meaning they have no control over the price of their product, as the price is determined by the market and is exogenous to the firm.

In perfect competition, a firm cannot raise its price because perfect substitutes are available, and buyers will switch to competitive firms.

In perfect competition, because price is exogenous and determined at the industry level, the individual firm's demand curve is horizontal. This means the firm can sell any quantity at the market price based on the overall supply and demand in the market.

In perfect competition, there's an equilibrium market price where the supply curve and demand curve intersect. This price is at the industry level and determines the prices for firms to sell their products.

In perfect competition, if demand increases, so does equilibrium market price, and if demand decreases, so equilibrium market price.

In perfect competition, price is constant as it's determined outside the firm.

The market price is determined at the industry level.

If marginal cost per unit is greater than marginal revenue, then we're losing profit.

If marginal revenue per unit greater than marginal cost, then we're increasing profit.

Marginal revenue is the amount of money gained by producing an addition unit of output.

In perfect competition, the profit maximizing level of output describes how much of a good should they produce given the market price.

In perfect competition, P=MR=AR=MC=D where P is price, MR is marginal revenue, AR is average price, MC is marginal cost and D is demand.

In perfect competition, the profit-maximizing output occurs where P = MR = MC. At this point, the firm maximizes its profit. Producing more than this output would cause MC to exceed MR, reducing profit. Producing less than this output would leave potential profit unearned because MR > MC, meaning the firm could still increase output to boost profit.

In perfect competition, average revenue $AR$ is the revenue per unit, i.e. the price.

Average revenue $AR$ is calculated by $TR/Q$.

Total revenue $TR$ is calculated by $P \times Q$, where P is price and Q is output.

In perfect competition, short run supply curve has the capital being fixed.

Profit is equal to total revenue (TR) minus total cost (TC). In other words: $Profit = TR-TC$.

Assumptions:

• The goal of the firm is to maximize profit ‒ maximize stockholders equity

• Short run ‒ Capital is fixed

• $\text{Profit}=TR-TC$ where $TR$ is total revenue and $TC$ is total cost.

In perfect competition, the profit maxizimation rule ensures that profit is maximized when marginal revenue (MR) and marginal cost (MC) are close together without marginal cost exceeding marginal revenue as that would lead to a lose in profit.

Parentheses around a number indicate a loss, i.e. negative value.

Total revenue is calculated as price (P) multiplied by quantity (Q). In other words TR = P * Q.

Total variable cost (TVC) is the product of average variable cost (AVC) and quantity (Q); i.e. $TVC=AVC \times Q$.

Profit per unit is the price (P) subtracted by average total cost (ATC); i.e. profit per unit is $P-ATC$.

Graphically, the vertical distance from the horizontal axis to the average total cost (ATC) curve at a specific quantity (Q) represents the average total cost for that quantity.

Average total cost cost per unit of output, which is calculated as the quotient between total cost and quantity; i.e. $ATC= \frac{TC}Q{}$.

A firm's total profit $\Pi$, is the profit per unit (P-ATC) multiplied by the quantity (Q); i.e. $\Pi=Q(P-ATC)$ where P is price and ATC is average total cost.

Total fixed cost (TFC) can be calculated as Q(ATC-AVC) which is equivalent to total cost (TC) - total variable cost (TVC). In other words: $TFC=Q(ATC-AVC) = Q(ATC)-Q(AVC)=TC-TVC$

In perfect competition, a firm's break even price is when price (P) is equal to minimum average total cost (ATC). This is true because P = minimum ATC means that the minimum cost per unit has been covered so the firm won't lose any money but also won't make a profit.

In perfect competition, if Price = minimum ATC, then it is also true that MR = MC. However, if MR = MC, it is not necessarily true that Price = minimum ATC.

At the break even point, the firm is earning a profit equal to its opportunity cost (fair rate of return on its investment).

In perfect competition, if the market price (P) is between the minimum AVC and minimum ATC, i.e. below the break even price but above the shut down price, a firm may choose to continue to produce at a loss in the short run. Doing so lets the firm recover the variable costs like labor and some of the fixed cost minimizing the loss compared to shutting down.

A firm's loss can be calculated as $Q(ATC-P)$, i.e. quantity multiplied by loss per unit.

In perfect competition, a firm may choose to produce at a loss in the short run when min ATC ≥ P ≥ min AVC.

In perfect competition, a firm's shutdown price is when the market price (P) falls below the average variable cost AVC. This means the firm can't recover its fixed nor variable costs and must shutdown as continuing production would add more to cost than revenue.

In perfect competition if market price (P) is $P \le min \ AVC$, then the firm must shut down as it can't recover any of its costs.

In perfect competition, the long run equilibrium price is equal to the minimum average total cost (ATC); P = minimum ATC.

In perfect competition, firms can freely enter or exit the market in the long run. If firms earn above a normal rate of return, new firms enter, increasing supply and lowering the price. Conversely, if firms incur losses, some will exit, reducing supply and raising the price. This process continues until firms earn a normal rate of return, where the price equals the minimum average total cost. This price is called the long-run equilibrium price.

In perfect competition, prices are forced down to the minimum ATC.

In a free market, competition guarantees the consumer will get the lowest possible price that still guarantees a fair rate of return for the producer.

Diminishing returns sets in when marginal cost is at a minimum.

Short run supply curve under Perfect Competition:

• In perfect competition, a firm's short-run marginal cost curve above the minimum AVC (shutdown price) is its short-run supply curve. This is because the firm, as a price taker, maximizes profit by producing where P = MC. If the price falls below the shutdown price, the firm cannot cover its variable costs and stops producing, making supply zero.