Perfect Competition: A Context Rich Problem
and is replicated here as part of the SERC Pedagogic Service.
This activity consists of a single problem given to students to solve. The students are asked to find the profit-maximizing level of output for a perfectly competitive firm, and check the shut-down condition for two different prices.
1) Identify perfectly competitive firms by the market characteristics
2) Calculate marginal and average variable costs
3) Apply the profit maximizing condition of price=marginal cost
4) Apply the shut-down condition of price less than average variable cost
Context for Use
The activity is appropriate for any size class. It can be completed inside or outside of class. It can be done individually or in small groups.
Description and Teaching Materials
Your family recently began operating a car wash at a beach resort. There are many other car washes at this beach resort. You have observed that the customers care only about finding the cheapest price for car washes; they do not care which company they use. Your family purchased the equipment and the building for the car wash. They were able to spend $1,000 of their savings to go towards this purchase. To cover the rest of this expense, they took out a small business loan. The cost of the loan comes to $15 per day for the next 3 years. The business must hire labor and purchase cleaning solutions, car wax, etc. to operate the car wash. After some research you have figured out . . .
The full text of the problem is in the handout. It can be given to students as is if you wish them to complete the assignment individually outside of class time. The instructions can easily be modified if you wish to do the problem as an in-class assignment. The activity can be completed in class in 10-15 minutes. Students can also be assigned to work together in small groups to complete the activity.
Perfect Competition CRP Handout (Microsoft Word 26kB Feb16 09)
Once the exercise has been completed by the students, the instructor can use the Excel file to check calculations.
Cost calculations for Perfect Competition CRP (Excel 26kB Feb16 09)
Teaching Notes and Tips
1) Characteristics of perfect competitionIf the activity will be done as an in-class exercise, make sure the students are told to bring calculators to class.
2) Definitions of fixed, variable, marginal and average variable costs
3) Profit maximization for perfectly competitive firms
4) Shut-down condition