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Transcript
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, but it can sell
as much as it wants at that price. The demand
curve, therefore will be “perfectly elastic”
(horizontal) at the market 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
Market
S
AR = MR
Mkt
Price
D
Qpm
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
AR = MR
Mkt
Price
Supernormal
Profits
Qpm
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 – short run
£
£
MC
P
Individual Firm – long run
Market
S £
S1
AC
P1
AR = MR
MC1
AC1
AR1 = MR1
D
Qpm
Q
Q
Qpm
Q
In the short run, if price is above AC, firms earn supernormal profits –
this attracts firms into the industry, lowering price and eroding
supernormal profits back to normal profits in long run.
Perfect Competition – short run / long run
Price £
Individual Firm
Price £
Market
MC
AC
S
Loss
Mkt
Price
AR = MR
D
Qpm
Quantity
Quantity
If, in the short run, mkt price is below ave. cost, firms can make
losses – this leads firms to leave the industry
Perfect Competition – short run / long run
Individual Firm – short run
£
Individual Firm – long run
Market
£
£
MC
MC1
AC
S1
P
AC1
S
AR1 = MR1
AR = MR
D
Qpm
Q
Q
Qpm
Q
If, in the short run, mkt price is below ave. cost, firms can make
losses – this leads firms to leave the industry, raising price and profits
back to the “normal” level for remaining firms.
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
Let’s think about what the firm’s
supply curve might look like…
(not on the spec… just interesting)
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.
Dynamic
Efficiency
Producers will strive to
keep up with each other so
as to make normal profit at
the market price
equal access
barriers to entry/exit
insignificant
homogeneous
complete information
no costs
costless
competition
Price taker
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