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Perfect CompetitionPerfect Competition

In the words of left witch,“perfect competition is a market inwhich there are many firms selling

identical products, with no firm largeenough relative to the entire marketto influence market prices.

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A Perfectly Competitive MarketA Perfectly Competitive Market

• A perfectly competitive market mustmeet the following requirements:

q  B o th b u ye rs a n d se lle rs a re p rice.takers

q .T h e n u m b e r o f firm s is la rg e

q .T h e re a re n o b a rrie rs to e n try

q ’ .T h e firm s p ro d u cts are id e n tica l

q .T h e re is co m p le te in fo rm a tio n

q .Firm s a re p ro fit m a xim ize rs

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The Definition of Supply and PerfectThe Definition of Supply and PerfectCompetitionCompetition

• Supply  is a schedule of quantities of goods that will be offered to themarket at various prices.

• When a firm operates in a perfectlycompetitive market, it’s supplycurve is that portion of its short-run

marginal cost curve above averagevariable cost.

•

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Demand Curves for the Firm and theDemand Curves for the Firm and theIndustryIndustry

•  The demand curves facing the firm isdifferent from the industry demandcurve.

• A perfectly competitive firm’sdemand schedule is perfectlyelastic even though the demand

curve for the market is downwardsloping.

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Demand Curves for the Firm and theDemand Curves for the Firm and theIndustryIndustry

• Individual firms will increase theiroutput in response to an increase indemand even though that will

cause the price to fall thus makingall firms collectively worse off.

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 Market supply

Marketdemand

,1 000 ,3 000

Price

$10

8

6

4

2

0Quantity

Market Firm

Individual firmdemand

Market Demand Versus Individual FirmMarket Demand Versus Individual FirmDemand CurveDemand Curve

10 20 30

Price

$10

8

6

4

2

0Quantity

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The Marginal Cost Curve Is the Firm’sThe Marginal Cost Curve Is the Firm’sSupply CurveSupply Curve

 A

B

C

Marginal cost

Cost,P

rice

$70

60

50

40

30

20

10

0 1 Quantity2 3 4 5 6 7 8 9 10

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) Profit case ( )b Zero profit case ( )c Loss case

Determining Profits GraphicallyDetermining Profits Graphically

Quantity Quantity Quantity

Price

 65 60 55 50

 45 40 35 30 25 20

 15 10 5

0

 65 60 55 50

 45 40 35 30 25 20

 15 10 5

01 2 3 4 5 6 7 8 910 12 1 2 3 4 5 6 7 8 9 10 12

D 

MC 

A  = P MR 

B  ATC 

AVC E 

Profit

C 

MC 

ATC 

AVC 

MC 

ATC 

AVC 

Loss

 65 60 55 50

 45 40 35 30 25 20

 15 10 5

01 2 3 4 5 6 7 8 910 12

= P MR 

= P MR 

PricePrice

- , . ,T h e Mc G ra w Hi ll C om p an ie s I nc 20 0 0-r win M cGr aw H il l

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Short-Run Market Supply and DemandShort-Run Market Supply and Demand

While the firm's demand curve isperfectly elastic, the industry's isdownward sloping.

For the industry's supply curve we usea market supply curve.

 The market supply curve is the

horizontal sum of all the firms'marginal cost curves, taking accountof any changes in input prices that

might occur.

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Long-Run Competitive EquilibriumLong-Run Competitive Equilibrium

• Profits and losses are inconsistentwith long-run equilibrium. – Profits create incentives for new firms

to enter, output will increase, andthe price will fall until zero profitsare made.

 – The existence of losses will cause

firms to leave the industry. Only at zero profit will entry and exit

stop.

The zero profit condition defines the long-

run equilibrium of a competitive industry.

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Long-Run Competitive EquilibriumLong-Run Competitive Equilibrium

MC 

P = MR 

0

60

50

40

30

20

10

Price

2 4 6 8 Quantity

SRATC  LRATC 

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An Increase in DemandAn Increase in Demand

• An increase in demand leads tohigher prices and higher profits. – Existing firms increase output.

 – New firms enter the market,increasing output still more.

 – Price falls until all profit is competedaway.

In the short run, the price does more of the adjusting.

In the long run, more of the adjustmentis done by quantity.

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Advantages of Perfect Competition:Advantages of Perfect Competition:

 H ig h d e g re e o f co m p e titio n h e lp s a llo ca te re so u rce s to m o st e fficie n t

u se

=Price m a rg in a lco sts

 N o rm a l p ro fit m a d e in th e lo n g ru n

 Firm s o p e ra te a t m a xim u me fficie n cy

 C o n su m e rs b e n e fit

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What happens in a competitiveWhat happens in a competitiveenvironment?environment?

–N e w id e a ? firm m a ke s sh o rt te rm a b n o rm a l p ro fit

 O th e r firm s e n te r th e in d u stry to

 ta ke a d va n ta g e o f a b n o rm a lp ro fit –S u p p ly in cre a se s p rice fa lls –Lo n g ru n n o rm a lp ro fit m a d e  C h o ice fo r con su m e r  Price su fficie n t fo r n o rm a lp ro fit to

!b e m a d e b u t n o m o re

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PRODUCT DIFFERENTIATIONPRODUCT DIFFERENTIATION

 Pro d u ct d iffe re n tia tio n is o f vita l im p o rta n ce in p ro d u ct m a n a g e m e n t

 H as g re a t p o te n tia l in fo rg o in g su cce ssfu lm a rke tin g stra te g ie s

:A b u sin e ss le ve l stra te g y in te n d e d to  In cre a se th e p e rce ive d va lu e o f th e fo ca l

’ /firm s p ro d u cts a n d o r se rvice s re la tive to

’ /th e va lu e o f co m p e tito r s p ro d u cts a n d o rse rvice s  C re a te a cu sto m e r p re fe re n ce fo r th e

’ /fo ca lfirm s p ro d u cts an d o r service s

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BasisBasis of Differentiationof Differentiation 

• A base of differentiation must fill some customer need:

 – Image, hunger, comfort, cleanliness, beauty, status,style, taste, safety, quality, service, accuracy,furthering a cause, reliability in use, nostalgia,

 belonging.

• A differentiated product fills one or more needs better than the products of competitors

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BASIS OF DIFFERENTIATIONBASIS OF DIFFERENTIATION

I.Tangible product attributes

I.Intangible attributes and emotional associations

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TANGIBLE PRODUCTTANGIBLE PRODUCT

ATTRIBUTESATTRIBUTES

§ /IN G R E D IE N T S FO R M U LA.:e x C LO S E U P W IT H G E L

§  FU N C TIO N A L FE AT U R E S.:E x sou th w e st a irlin e s

§  D IFFE R E N T IA T IO N B A S E D O N

 A D D IT IO N A L FE A T U R E S.:E x m o b ile p h o n e w ith a d d e dfu n ctio n s

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 D IFFE R E N T IA T IO N O N PA C K A G IN G.:Ex kurkure engages consumers through packaging

 Differntiation through product/design styling

.:Ex titan watches

 Differentiation on product/quality technology

.:Ex Lg refridgerators

 DIFFERENTIATION BASED ON CUSTOMERCARE AND SERVICES

.:Ex dominos pizza

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DIFFERENTIATION ONDIFFERENTIATION ON

INTANGIBLE ATTRIBUTESINTANGIBLE ATTRIBUTES

/PRESTIGE STATUS.:Ex dinesh suitings

Sentiments.:ex ray ban sunglasses

BELIEFS

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Essence of DifferentiationEssence of Differentiation

 Poor differentiation  Excellentdifferentiation

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SummarySummary

• Product differentiation creates customer preferences

• Preferences allow firms to make above normal profits

• Almost anything can be a base of differentiation

• Bases of product differentiation that meet the VRIOcriteria may generate competitive advantage

• A product differentiation strategy is only as good asits implementation

• Product differentiation principles can be applied toyour personal and professional lives