Transcript Perfect-Competition

Perfect Competition
• Many buyers & sellers (no individual has mkt
power)
• Homogeneous product – no branding or
differentiation
• Perfect information – consumers always know
what’s on offer for what prices
• Freedom of entry & exit – no “barriers to entry”
So… firms are price takers.
The Demand Curve in Perfect
Competition
• Since the firm is a price taker and an insignificant
part of the total market, the individual firm has no
control over the price it can charge. The demand
curve, therefore will be “perfectly elastic”
(horizontal) at the market price. The firm can sell an
infinite amount at that one price.
• Since this demand curve has the same price
(average revenue) at all quantities, AR will be equal
to MR.
Perfect Competition
– Cost Curves
Price £
Individual Firm
Price £
MC
AC
Mkt
Price
Market
S
AR = MR
D
Quantity
Quantity
Price is determined in the market – firms can sell as much as they like at this price.
Perfect Competition – Short Run / Long Run
Price £
Individual Firm
Price £
Market
S
MC
AC
Mkt
Price
AR = MR
Supernormal
Profits
Quantity
D
Quantity
If, in the short run, if mkt price is above AC, firms can earn
supernormal profits – this attracts more firms into the industry
Perfect Competition – Short Run / Long Run
Individual Firm
S £
£
£
MC
P
Individual Firm
Market
MC1
AC
P1
AR = MR
AC1
AR1 = MR1
D
D1
Q
Q
Q
In the short run, if price is above AC, firms earn supernormal profits –
this attracts firms into the industry, eroding supernormal profits back
to normal profits in long run. (↓ D and ↑ AC with more competitors.)
Perfect Competition – short run / long run
Price £
Individual Firm
Price £
Market
MC
AC
S
Loss
Mkt
Price
AR = MR
D
Quantity
Quantity
If, in the short run, mkt price is below ave. cost, firms fan make losses
– this leads firms to leave the industry
Perfect Competition – short run / long run
Market
Individual Firm
£
Individual Firm
£
£
MC
MC1
AC
AC1
S
P
AR1 = MR1
AR = MR
D
Q
D1
Q
Q
If, in the short run, mkt price is below ave. cost, firms fan make losses
– this leads firms to leave the industry, raising profits back to the
“normal” level for remaining firms. (↑D and ↓AC with less competitors)
Perfect Competition – Long Run
Price £
Individual Firm
Price £
MC
AC
Mkt
Price
Market
S
AR = MR
D
Quantity
Quantity
Perfect competition – shut down point
Price £
Individual Firm
Price £
MC
SRATC
Mkt
Price
Market
S
SRAVC
AR = MR
D
Quantity
Quantity
This firm is making a loss. But they will continue producing in the short run because
P ˃ SRAVC.
Perfect competition – shut down point
Price £
Individual Firm
Price £
Market
MC
S
SRATC
Mkt
Price
SRAVC
AR = MR
D
Quantity
This firm is making a loss. They will shut down because P ˂ SRAVC.
*Shut down point is where P = SRAVC*
Quantity
Perfect Competition Efficiency
Allocative
Efficiency

Since P = MR, and the firm
will produce where MR =
MC, then MC = P
Productive
Efficiency

In the long run, production
will settle at the min. AC.
Evaluating the
Perfect Competition Model
• Strong assumptions are made about
- homogeneity of product
- absence of sunk costs
- freedom of entry/exit
- complete information being available
• This “perfect” situation rarely exists