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Unit 4: Perfect & Imperfect Competition - Coggle Diagram
Unit 4: Perfect & Imperfect Competition
Lesson 1: Perfect Competition
Characteristics (Pure Competition):
Very Large Number of Sellers: So many firms, none can influence market price.
Standardized Product: All products are identical; buyers are indifferent to sellers.
Easy Entry & Exit: No barriers to joining or leaving the industry.
Price Takers: Individual firms accept the market price; they have no pricing power.
No Non-price Competition: Focus is solely on price.
Demand for a Purely Competitive Seller:
Perfectly Elastic Demand: The firm's demand curve is a horizontal line at the market price.
My Understanding: This means the firm can sell all it wants at the going market price, but if it tries to charge even a tiny bit more, it sells nothing, as consumers will just buy from identical competitors.
Small Market Share: Each firm's output is a minuscule fraction of total industry output.
Lesson 2: Profit Maximization
This lesson explores the methods purely competitive firms use to maximize profits or minimize losses in the short run.
Short-Run Profit Maximization: Key Questions
A firm must answer: 1. Should it produce? 2. If so, how much? 3. What will be the resulting profit or loss?
Approaches to Profit Maximization/Loss Minimization:
1. Total-Revenue (TR) – Total-Cost (TC) Approach:
Concept: Identify the output level where the difference between Total Revenue (TR) and Total Cost (TC) is maximized (for profit) or minimized (for loss).
Formulas: TR = Quantity (Q) × Price (P); Profit/Loss = TR - TC.
Graphical: Find the largest vertical gap between the TR curve (straight, upsloping) and the TC curve (S-shaped). Break-even points are where TR = TC.
2. Marginal-Revenue (MR) – Marginal-Cost (MC) Approach:
Rule: Produce where Marginal Revenue (MR) equals Marginal Cost (MC). This rule applies to all market structures.
Condition for Production: Firm must produce if Price (P) ≥ Average Variable Cost (AVC).
MR in Pure Competition: P = MR = AR (perfectly elastic demand).
Decision Process:
If MR > MC: Increase output.
If MR < MC: Decrease output.
If MR = MC: Optimal output for profit maximization/loss minimization.
Graphical: The intersection of the horizontal demand curve (P=MR=AR) and the MC curve determines optimal output. Compare P with ATC to find profit/loss.
Short-Run Shutdown Decision:
Rationale: Fixed costs are sunk in the short run. The firm decides whether to produce or temporarily shut down.
Rule: Shut down if Price (P) falls below Average Variable Cost (AVC).
My Understanding: If selling a unit doesn't even cover its direct production cost, stop producing to limit losses to just fixed costs.
Competitive Firm's Short-Run Supply Curve:
Definition: The segment of the firm's Marginal Cost (MC) curve that lies above its Average Variable Cost (AVC) curve.
My Understanding: This shows the quantities a firm is willing to supply at different prices, as long as those prices cover variable costs.
Lesson 3: Imperfect Competition (The Real World)
This lesson focuses on monopolistic competition, a more common market structure.
Approaches to Profit Maximization/Loss Minimization:
1. Total-Revenue (TR) – Total-Cost (TC) Approach:
Concept: Identify the output level where the difference between Total Revenue (TR) and Total Cost (TC) is maximized (for profit) or minimized (for loss).
Formulas: TR = Quantity (Q) Price (P); Profit/Loss = TR - TC.
Graphical: Find the largest vertical gap between the TR curve (straight, upsloping) and the TC curve (S-shaped). Break-even points are where TR = TC.
2. Marginal-Revenue (MR) – Marginal-Cost (MC) Approach:
Rule: Produce where Marginal Revenue (MR) equals Marginal Cost (MC). This rule applies to all market structures.
Condition for Production: Firm must produce if Price (P) Average Variable Cost (AVC).
MR in Pure Competition: P = MR = AR (perfectly elastic demand).
Decision Process:
If MR > MC: Increase output.
If MR < MC: Decrease output.
If MR = MC: Optimal output for profit maximization/loss minimization.
Graphical: The intersection of the horizontal demand curve (P=MR=AR) and the MC curve determines optimal output. Compare P with ATC to find profit/loss.
Short-Run Shutdown Decision:
Rationale:
Fixed costs are sunk in the short run. The firm decides whether to produce or temporarily shut down.
Rule
: Shut down if Price (P) falls below Average Variable Cost (AVC).
My Understanding:
If selling a unit doesn't even cover its direct production cost, stop producing to limit losses to just fixed costs.
Competitive Firm's Short-Run Supply Curve:
Definition
: The segment of the firm's Marginal Cost (MC) curve that lies above its Average Variable Cost (AVC) curve.
My Understanding
: This shows the quantities a firm is willing to supply at different prices, as long as those prices cover variable costs.