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Perfect Competition

Perfect Competition. Chapter 14: Pages 289-306. 4 Market Structures. Market Structure is the way an industry is organized: Auto Industry versus Restaurant Industry. These 4 Determine degree of price control. Market Characteristics. 5 market characteristics of firms:

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Perfect Competition

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  1. Perfect Competition Chapter 14: Pages 289-306

  2. 4 Market Structures • Market Structure is the way an industry is organized: • Auto Industry versus Restaurant Industry

  3. These 4 Determine degree of price control Market Characteristics • 5 market characteristics of firms: • # of Firms • Type of Product • Ease of entering or exiting industry • Amount of Information • Degree of Price Control

  4. Perfect Competition • Is an economic theory • It does not exist in the “real world” • The model is perfectly “self-regulating” • Economic Profit must = zero in long run • Economic profit can exist only in short run • new firms enter market => ↓ economic profit to ZERO • Economic loss can exist only in short run • some firms exit market => ↑ economic profit = ZERO • Zero economic profit means you earn a “fair” accounting profit

  5. Perfect Competition Market Characteristics • Many small firms • think unlimited supply of firms • Homogenous products • exactly the same! • Complete freedom to enterorexit industry • No costs, immediate action • Perfect information • Price Taker: • No price control—sell at current Market Price

  6. Perfect Competition in “Action” • All competitive firms are small & can quickly enter/exit industry • No costs to enter/exit, immediate action • Actions of a single buyer/seller has no impact on market price • Competitive firms can sell all of their output at market price (price taker) • Short Run: Competitive firms enter industries with economic profit • Exit any industry with an economic loss • Long Run: Price = Minimum of ATC &economic profit = ZERO • If economic profit > 0 => new firms enter market => price falls to min ATC • If economic profit < 0 => some firms exit market => price rises to min ATC

  7. AVC ATC D1 = MR $10 Long Run Equilibrium (perfect competition) Long Run Equilibrium Economic Profit = Zero Price = Min. of ATC Entire Industry Individual Firm T-Shirts T-Shirts Price S1 Price MC -------------- $10 E1 E1 ------------- ------------- D1 Q1 Q1 Qty Qty Individual firms can sell all of their production at the current Market Price (price taker!) So for 1 firm => Price = MR = D

  8. Perfect Competition in Action • In perfect competition, new firms will enter the market as long as there is excess profit • When profits are less than zero—firms exit the market • Benefits of Perfect Competition • Prices remain low & profits are pushed to zero • inefficient producers are forced to leave • Perfectly “self regulating” system

  9. Worksheet

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