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Understanding Perfect Competition in Market Structures

Explore the concept of perfect competition, a theoretical model that defines how industries are organized and the characteristics that determine the degree of price control. Learn how economic profit must equal zero in the long run and how firms in perfect competition act as price takers. Discover the equilibrium and actions taken by firms in the short and long run.

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Understanding Perfect Competition in Market Structures

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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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