Chapter 14: Firms in Competitive Market

Perfectly Competitive Market
• Competitive market:
• A market with many buyers and sellers trading identical products so that each
buyer and seller is a price taker

Characteristics of a Perfectly Competitive Market
•A perfect competition holds the following
characteristics;
• There are many buyers and sellers in the market
• The products sold in the market are homogenous goods (i.e.
products are identical in quality, size etc.)
• No Barriers to entry in the market, the firms can freely enter
into the market
• Firms have a small market share, and no firm has an
influence over market prices
• Markets are Price Makers while Firms are Price Takers
• Buyers and sellers have complete information of the
products

Examples for products in perfectly
competitive market
They are all
identical in
characteristics

Recall; The Market Equilibrium
• In a perfectly competitive market, markets decides the price of
the products and firms have to sell at that price.
The forces of Demand and
Supply determine the
Market Prices and Market
Quantity.
The Price for a perfectly
competitive firm is
P = MR = AR

Recall; The cost curves of firm in the short-
run
•At point A: MC = AC
shows the point having
minimum Average total
costs
• and
•At point B: MC = AVC
shows the point having
minimum Average
variable costs
A
B

Firms are Price Takers in the Market
• The Prices are determined by the Market. The firm’s Costs are minimized at
Point B (where MC=ATC), Price for firm is equal to Average Revenue and
Marginal Revenue.

Profit Maximization is where MC = MR (Marginal
costs equal to Marginal Revenue)

Profit for a Firm in perfect competition
• Under perfect competition, firms can make Super-Normal
Profit or losses.
At Point A the
profit is
maximized
while the gap
between ATC
and Point A is
the area of
Profit
Here.
MR > ATC
So there is
Profit

Profit, Loss and Shutdown points
of a firm in a perfectly
competitive market
4 different Cases
Remember,
P = Market Price
MC = Marginal Cost
MR = Marginal Revenue
AR = Average Revenue
ATC = Average Total Cost
AVC = Average Variable Cost

1. Profit for a firm
YELLOW region is the
profit area of the firm as;
ATC < MR
AVC < MR
This shows that firm is
having Profit
If marginal revenue is
greater than marginal
cost, the firm should
increase its output.

2. No Profit/Loss for a firm
Here is No Profit and
Loss for a firm as;
ATC = MR
AVC < MR
Firm needs to reduce
cost to gain Profit

3. Loss for a firm
BLUE region is the Loss
area of the firm as;
ATC > MR
AVC < MR
This shows that firm is
having Loss but the firm
survives in the market
If marginal cost is greater
than marginal revenue,
the firm should decrease
its output

4. Shutdown point for a firm
Here the firm will
shutdown because
ATC > MR
AVC > MR
This shows that firm is
having Loss even higher
than AVC so the firm will
shutdown and stop
working

Learning Outcomes for this Lecture:
Because a competitive firm is a price taker, its revenue is proportional to the amount
of output it produces. The price of the good equals both the firm’s average revenue
and its marginal revenue.
To maximize profit, a firm chooses a quantity of output such that marginal revenue
equals marginal cost. Because marginal revenue for a competitive firm equals the
market price, the firm chooses quantity so that price equals marginal cost. Thus, the
firm’s marginal-cost curve is its supply curve.
In the short run when a firm cannot recover its fixed costs, the firm will choose to
shut down temporarily if the price of the good is less than average variable cost. In
the long run when the firm can recover both fixed and variable costs, it will choose to
exit if the price is less than average total cost

Thank you for Listening