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Perfect Competition

Perfect Competition. John R. Swinton, Ph.D. Center for Economic Education Georgia College & State University. Perfect Competition. Question: Suppose that roses are produced in a perfectly competitive, increasing-cost industry in long-run equilibrium with identical firms.

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Perfect Competition

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  1. Perfect Competition John R. Swinton, Ph.D. Center for Economic Education Georgia College & State University

  2. Perfect Competition • Question: • Suppose that roses are produced in a perfectly competitive, increasing-cost industry in long-run equilibrium with identical firms. • Draw correctly labeled side-by-side graphs for the rose industry and a typical firm and show each of the following: • Industry equilibrium price and quantity, labeled Pm and Qm, respectively. • The firm’s equilibrium price and quantity, label Pf and Qf, repectively.

  3. Perfect Competition • Assumptions: • Price Takers (buyers AND sellers) • Large Number of Sellers and Buyers • No Barriers to Entry • Identical Products • Complete Information • Profit-maximizing Behavior

  4. Perfect Competition • Individual Firm Decision: • Rule #1: Set Output such that MC=MR • MR = Market Price (because the firm is a price taker) • IF MR < min AVC then Shut Down! • IF MR > min AVC but < min ATC then Stay Open in the short run and Shut Down in the long run • IF MR ≥ Min ATC then Stay Open

  5. Perfect Competition • Graphically: Price good X MC ATC Min ATC 0 Quantity good X

  6. Perfect Competition • Graphically: Price good X Supply MC ATC Min ATC 0 Quantity good X Shut Down Produce

  7. Perfect Competition • Meanwhile, the Market: Price Roses Supply (or MC) Pm Demand (or MB) 0 Quantity Roses Qm

  8. Perfect Competition • Meanwhile, the Market: Price Roses Supply (or MC) Pm Demand (or MB) 0 Quantity Roses Qm

  9. Perfect Competition • Graphically: Price Roses MC ATC Pm=Pf=MR Min ATC 0 Quantity Roses Qf

  10. Perfect Competition • Assume there is an increase in demand for Roses. Price Roses Supply (or MC) New Pm Pm New Demand (or MB) Demand (or MB) 0 Quantity Roses Qm New Qm

  11. Perfect Competition • Short-run reaction: Price Roses MC New Pm=Pf ATC Pm=Pf=MR 0 Quantity Roses Qf New Qf

  12. Perfect Competition • Short-run reaction: Price Roses MC New Pm=Pf ATC Profits 0 Quantity Roses New Qf

  13. Perfect Competition • Long-run: • Profits attract entry of identical firms. Price Roses Supply (or MC) New Pm Pm New Demand (or MB) Entry 0 Quantity Roses New Long-run Qm New Qm

  14. Perfect Competition • Long-run reaction: • As firms enter the price returns to its original level Price Roses MC New Pm=Pf ATC Original Pm=Pf=MR 0 Quantity Roses Original Qf New Qf

  15. Perfect Competition • Results: • Number of firms will increase – because they were attracted by the profits created by the increase in demand. • Each firm’s ATC will remain exactly where it was before – nothing in the question impacts the cost of production. • Profit maximizing price will be exactly as it was in the original part – the firms that entered were exactly the same as the ones that were already in the industry so their ATC look the same. • Profits will be zero once again.

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