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Economics 2

Lecture 20: Perfect Competition in the Short Run

characteristics of a perfectly competitive market
demand curve facing a perfect competitor
what does the MR curve look like for a perfect competitor?
profit maximization

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Charcteristics of a Perfectly Competitive Market

1. many buyers and many sellers
2. identical product
3. free entry and exit
4. perfect information

Demand Curve Facing a Perfect Competitor

The market price in a perfectly competitive market is determined by the market supply and demand curves. An individual firm in that market cannot charge more than the market price and will not charge less. So, the demand curve facing an individual firm is horizontal at the market price, that is, it is perfectly elastic.

What Does the MR Curve look like for a Perfect Competitor?

A firm maximizes profits by producing where MR=MC. For a perfectly competitive firm, the marginal revenue curve is the same as the demand curve.

 Q	P	TR	MR

 0     $1       $0       -
 1	1	 1	$1
 2	1	 2	 1
 3	1	 3	 1
 4	1	 4	 1

Profit Maximization

A perfectly competitive firm faces a perfectly elastic demand curve at the market price.

Profits are maximized by producing the quantity at which marginal revenue equals marginal cost. Since price equals marginal revenue for a perfect competitor, profits are maximized when price equals marginal cost. This occurs where the marginal cost curve intersects the demand curve. The profit maximizing quantity is 15 units of output. The price is the market price of $10. The firm's average cost is $6 per unit of output. So, the firm makes a profit of $10 - $6 = $4 per unit of output. Total profits are 15 x $4, $60.

David A. Latzko Business and Economics Division Pennsylvania State University, York Campus office: 13 Main Classroom Building voice: (717) 771-4115 fax: (717) 771-4062 e-mail: web: www.yk.psu.edu/~dxl31