Perfect Competition and Profit
Table of Contents
This section covers the following topics:
- Requirements for perfect competition
- Profit maximization where MC = MR
- Finding profit and loss in a graph
- Long-run supply
- The shutdown decision
Section Summary
In a perfectly competitive market, there are a large number of firms, both buyers and sellers are price-takers, the firms produce identical products, have perfect information, are not protected by any barriers to entry and attempt to maximize profit. The market demand curve for a perfectly competitive firm is normal, but the demand curve perceived by the firm is horizontal.
Profit is maximized when marginal cost = marginal revenue. You can determine the profit or loss that a firm makes from a graph by finding the quantity of goods produced, price per good and average total cost per good. In the long-term, firms in a perfectly competitive market can only make a normal profit, which covers their opportunity cost.
The long-run supply curve can be horizontal (in a constant cost industry), upward sloping (in an increasing cost industry) or downward sloping (in a decreasing cost industry).
Firms reach the shutdown point, where they lose less money by halting production entirely, when average variable cost equals price.
Perfectly Competitive Markets
Overview
One of the main market structures you are expected to understand is the perfectly competitive market. There are six requirements that must be met to make a market perfectly competitive, as outlined below. Real-world markets for basic commodities can be fairly close to being perfectly competitive.
In a perfectly competitive market
- There are a large number of firms – There are enough firms that price fixing or collusion is impossible. Firms don’t take the actions of their competitors into account, because the market is so fragmented.
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No barriers to entry exist – Nothing stops new firms from entering the market. This...
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