Perfect

Competition
Group 1
Joshua Siong
Ravi Roi Ybanez
Romy Kristoffer Jauculan
Danrell Dingal Calumpong
Joshua Tamayo
Jade Lawrence Bacus
I. Summary
A perfectly competitive firm is a price taker, which means that it must accept the
equilibrium price at which it sells goods. If a perfectly competitive firm attempts to
charge even a tiny amount more than the market price, it will be unable to make any
sales. In a perfectly competitive market there are thousands of sellers, easy entry, and
identical products. A short-run production period is when firms are producing with
some fixed inputs. Long-run equilibrium in a perfectly competitive industry occurs
after all firms have entered and exited the industry and seller profits are driven to
zero.

Perfect competition means that there are many sellers, there is easy entry and exiting
of firms, products are identical from one seller to another, and sellers are price takers.

II. Introduction
Theoretically, perfect competition leads to low prices and high quality for the
consumer. There are no regulations or other external factors affecting decisions
made by producers. They are only guided by the forces of supply and demand. In a state of
perfect competition, an economy will operate at maximum efficiency. Surpluses and
shortages will be met, prices will meet demand, and producers will have to produce goods
and services at competitive quality.
Of course this is only theoretical, so instead, perfect competition is a sort of
model that is used to explain how competition works, rather than a statement of any reality
of economics.
III. Objective of the Report

 To understand and detect the goods of perfect competition and the trend of
perfectly competitive market
 To help us make a clear understanding about the perfect competition
market and what will be the decision of industry in different condition

IV. Definition of Perfect Competition

Perfectly competitive market is a market structure in which the following five

criteria are met: 1) All firms sell an identical product; 2) All firms are price takers –
they cannot control the market price of their product; 3) All firms have a relatively
small market share; 4) Buyers have complete information about the product being
sold and the prices charged by each firm; and 5) The industry is characterized by
freedom of entry and exit. Perfect competition is sometimes referred to as “pure
competition.”

V. Characteristics of a Perfectly Competitive Market

In order to attain perfect competition, several factors need to be met. The

following list outlines some of the main factors:
 a) Knowledge is available to all buyers and sellers, and no individual has
control over the prices.
b) Buyers and sellers have no barriers to enter or leave the market.
c) Buyers and sellers want to maximize profit.
d) There are too many sellers and buyers to take control of the market.
e) All goods are homogeneous.
f) The government dues not get involved.
g) There are no costs associated with transportation

VI. Influencing Factors of Perfectly Competitive Market

Fixed costs are costs that are independent of output. These remain constant
throughout the relevant range and are usually considered sunk for the relevant range
(not relevant to output decisions)

Variable costs are costs that vary with output. Generally variable costs increase
at a constant rate relative to labor and capital.

Total Fixed Cost (TFC) – Total amount paid for fixed input. Total fixed cost
does not vary with output

Total Variable Cost (TVC) – Total amount paid for variable input. Total
variable cost increase in output.

Total Cost (TC) describes the total economic cost of production and is made up
of variable costs, which vary according to the quantity of a good produced and
include inputs such as labor and raw materials, plus fixed costs, which are
independent of the quantity of a good produced and include inputs (capital) that
cannot be varied in the short term, such as buildings and machinery.
TC=TVC+TFC
Total cost in economics includes the total opportunity cost of each factor of
production as part of its fixed or variable costs.

The total cost curve, if non-linear, can represent increasing and diminishing marginal
returns.

Average Total Cost (ATC)

Total cost divided by the number of units of output.

ATC=TC/Q

Average Variable Cost (AVC)

Total variable cost divided by the number of units of outputs

AVC=TVC/Q

Marginal cost (MC):

The increase in total cost that result from producing one more unit of output.
Marginal costs reflect changes in variable costs
 Marginal revenue (MR):
The additional revenue that a firm takes in when it increases output by one additional
unit. In perfect competition, P=MR

Short-run Marginal Cost:

Short-run Marginal Cost is defined as the change in either total variable cost or total
cost per unit change in output.
SMC= ∆TVC/∆
= ∆TC/Q

Total revenue (TR):

The total amount that a firm takes in from the sale of its product: the price per unit
times the quantity of output the firm decides to produce
(P x q)

VII. Short-run Profit Maximization

Short run:
The period of time for which two conditions hold: the firm is operating under a fixed
scale (fixed factor) of production and firms can neither enter nor exit an industry. In
the short run a firm can go three types of condition-
 Make abnormal profit
 Make normal profit
 Make losses
Profit-Maximizing Level of Output
 What happens to profit in response to a change in output is determined
by marginal revenue (MR) and marginal cost (MC).
 A firm maximizes profit when MC = MR
 When profit, r =TR-TC is highest

A perfectly competitive firm will choose to produce an output where

1. MC = MR = P
2. MC curve cuts MR from below.
Mc Curve below MR means at such points Marginal Cost <> MR, then it means we
are
incurring more costs then the revenue earned or profit is negative as ∆Π /∆q = ∆R/∆q
– ∆C /∆q i.e. change in profit = MR - MC)

1. Super Normal Profit

In short run, we have fixed as well as variable factors of production. In short run, a
firm maximizes its profit by choosing an output at which MC=MR=price. The profit
is measured by the difference in AC and AR and competing the rectangle. The Profit
earned is super normal profit in this case.
 E is the equilibrium situation in perfect competition.
 At E, MC= MR.A firm will produce its output till point E only because it
maximizes its profit.
 AR=MR=P. (AR-AC) tells the average profit( profit for a unit) and
 to know total profit we have to multiply average profit with the number of
units sold(q). So, EACD is the profit that a firm will earn in short run

2. Loss in Short Run

 Not all firms make supernormal profits in the short run. Their profits
depend on the position of their short run cost curves. Some firms may be
experiencing Losses because their average costs exceed the
current market price. Other firms may be making normal profits where
total revenue equals total cost (i.e. they are at the break-even output). In
the diagram below, the firm shown has high costs such that the market
price is below the average cost curve. At the profit maximizing level of output, the

firm is making an economic loss.

 E is the equilibrium point. At this point MR= MC.
 Drawing a straight line from E to AC curve gives us the cost of the
product.
 Here, AC >AR(or price). So, the firm is incurring losses.
 A firm should shut down its production if it is incurring losses. Here AQ1
is the cost to the firm and EQ1 is the price of the product.

3. Normal Profit in short runs.

In short run, some firms may be making normal profits where total revenue equals
total cost (i.e. they are at the break-even output). In the diagram below, at
equilibrium, the firm has same costs such that the market price is equal to the
average cost curve. At the profit maximizing level of output, the firm is making a
normal profit.
 Profit-maximizing level of output and price
A PCM firms are trying to maximize their profits in either the short or long-term
and will produce the quantity at which MC = MR. Because the firm is a
price-taker, the price is set by the market forces of supply and demand. There are three
possible outcomes for the PCM firm in the short-run. If the ATC curve intersects
the MR curve at its lowest point, the firm will break even or earn a normal
economic profit as shown below in the first diagram. If the lowest point of the ATC
curve lies below the MR curve, the PCM firm will earn an "abnormal profit." The
yellow box in the second diagram represents the value of the abnormal profit.
Finally, if the lowest point of the ATC curve is above the MR curve, the PCM
firm will make a loss, represented by the pink box in the third diagram.
Short-run abnormal profits/losses
In the short-run, it is possible for a PCM firm to earn either an abnormal profit or
loss. Let's consider the case of earning an abnormal profit first. As
mentioned in the previous section, this occurs when the minimum point of the ATC
curve lies below the MR curve. Assuming perfect information, firms not already on
the market will notice that the aforementioned firm is earning an abnormal
profit. Eager to get in on the action, some of these firms will enter the market,
especially since there are no barriers to entry. This subsequent increase in supply
causes the price to fall. New firms will continue entering the market and the
price will continue to fall until the first firm earns a normal economic profit once
again. Now let's turn to a PCM firm earning a loss. As mentioned in the
previous section, a firm makes a loss when the minimum value of the ATC curve lies
above the MR curve. This may occur if too many firms have entered the market. Over
time, some firms will leave the market. This decrease in the supply of the good will
cause its price to increase. Firms that are able to "ride out the storm" will
find that they are no longer earning a loss, but a normal economic profit.
VIII. Shut-down Price, break even price
A company has broken even when its total sales or revenues equal its total
expenses. When a company breaks even they was no profit that has been made,
nor have any losses been incurred. A firm's shut down price is when its average
variable cost curve is above the marginal revenue curve. When this is true, it is
only a matter of time before the firm must leave the market. When firms leave a
market, the supply decreases, raising the profits of the firms who stay in the
market.

IX. Long-run Profit Maximization

In the long-run a PCM firm will earn a normal economic profit. It cannot earn an
abnormal profit in the long-run because firms will enter the market and the
 subsequent increase in supply will cause the price of the good to fall. Conversely,
the firm cannot earn a loss (provided it can cover its fixed costs) in the long-run
because firms will leave the market and the subsequent decrease in supply will
cause the price of the good to increase.

Efficiency in perfect competition

5 reasons why Perfect Competition is efficient:
1. Allocated Efficiency: This is because P = MC.
2. Productive Efficiency: Firms produce where MC=ATC.
3. X Efficient: Competition between firms will act as a spur to increase efficiency.
4. Resources will not be wasted through advertising because products are
homogenous.
5. Normal profit means consumers are getting the lowest price. This also leads to
greater equality in society.
X. Managerial Decision in Perfect Competition

General Rules for Implementation of the Profit-Maximizing Output Decision

At first a manager has to check out two things
 Produce as long as the market price is greater than or equal to minimum
average variable cost’s> AVC. Shut down otherwise
 Produce the output at which market price equals marginal cost : P=SMC
Step 1: Forecast product price
A manager must obtain a forecast of the price at which the completed can be sold

Step 2: Estimate AVC & SMC

AVC = a + bQ + cQ²
SMC = a + 2bQ + 3cQ³
 Step 3: Check shutdown rule
If P≥AVCmin, produce
If P<AVCmin, shut down
To find AVCmin, substitute Qmin into AVC equation
AVCmin=a+bQmin+cQ²min
Step 4: If P ≥ AVCmin, find output where P = SMC
 P = a + 2bQ* + 3cQ*²
Step 5: Compute profit or loss
 Profit = TR – TC
= P x Q* - AVC x Q* - TFC
=(P – AVC)Q* - TFC
 If P<AVCmin, firm shuts down & profit is -TFC
XI. Conclusion
Actually perfect competition market is the market of daily necessary products. In this
market a firm can make abnormal profit, normal profit and losses in the short run and
on the other hand the firm can make normal profit in the long run. Because there is no
entry and exit barrier of buyers and sellers in the perfect competition market.
Moreover, the buyers and sellers make the market price over bargain. In the
conclusion, by preparing this report we are now able how to apply the different rules
of perfect competition and make managerial decisions.

References

www.investopedia.com

www.economicsonline.co.uk

https://en.wikipedia.org

www.enotes.com