Perfect Competition

Perfect Competition
A hypothetical benchmark against which
to assess other market structures.
Actions of individual buyers and sellers
have no effect on the market price.
The relationship between marginal
revenue and price is the special feature of
perfect competition.
The horizontal demand curve is the crucial
feature of a perfectly competitive firm.

Horizontal Demand Curve

P
P

Whatever output (Q) the

firm sells, it gets
exactly the market
price (P).
The tiny firm can sell as
much as it wants at this
price.
> P = loses
< P =
attracts

To achieve the horizontal demand

curve
There must be many firms.
The firms must make a standardized
product.
Free entry and exit to the industry
Rise in revenues and profits would
attract new firms into the industry.
Some firms may choose to close down.

The firms supply decision

The firm uses the marginal condition
(MC = MR), then uses the average
condition.
A competitive firm does not bid down
the price as it sells more units of
output.
The marginal revenue from an additional
output is its price. (MR = P)

The firms short run supply

curve
Perfect competition makes
marginal revenue equal to
price
Hence, a competitive firm
produces output at which
price equal to marginal cost,
then checks whether zero
output is better.

The firms
supply decision
in the short run.
P1 is the
shutdown price
below which the
firm fails to
cover variable
costs in the
short run. At all
prices above P1,
the firm chooses
output to make
P= SMC

ENRTY AND EXIT

The corresponding to the
minimum point on the long run
average cost (LAC) curve.
There is no incentive to enter or
leave the industry.
The resources are tied up in the
firm are earning just as much as
their oppurnity costs.

 ENTRY is when new firms join

an industry.
EXIT is when existing firms
leaves.

INDUSTRY SUPPLY CURVES

Individual supply curve + individual supply
curve = industry supply curve
A competitive industry comprises many
firms.
SHORT RUN:
The quantity of fixed factors used by each firm.
The number of firms in the industry.

LONG RUN
- each firm can vary all its factors of production,
but the number of firms can also change through
entry and exit

Short run industry supply

curve
No. Of firms are given

Shows the quantity that producers

will supply at each price.
Shows how the quantity supplied by
an industry depends on the market
price given a fixed number of
producers.

Firms Short Run Supply

Curve
$

Break even or
normal profit
point

MC

ATC
MR3

P3
P2

MR2

P1

MR1
Shut down point

AVC
Q1

Q2

Q3

t prices below P1 the firm will shut At

down
prices between P 1and P2the firm will

produce where MC=MR at an economic los

At prices above P2 the firm will produce whe
MC=MR at an economic profit

The long run Industry

supply curve
Shows how the quantity supplied
responds to the price once producers
have had time to enter or exit the
industry.

The long run industry supply

curve
As market price
industry supply
1) each existing firm moves up its
long run supply curve.
2)new firms find it profitable to enter
the industry.
As market price
industry supply
1) at lower prices the all the firms
move down their long run supply curve.
2) some firms may leave the industry

 Firms can enter or leave the industry.

They will enter if there is economic
profit and leave if they are suffering
economic losses
Industry Supply curve is the
horizontal sum of the outputs
produced by the number of firms in
the industry at that price.
Long run supply curve is flatter than
short run supply
1. factors in the long run varies more
2. higher prices attracts extra firms in
the industry

Equilibrium in its Competitive Industry

Although each individual firm faces a horizontal
demand curve for its output, the industry as a whole
faces a downward-slopping demand curve for its
total output

Long-run Equilibrium
With fewer firms left,
the industry supply curve
SS shifts to the left. With less
supply, the equilibrium price
rises. When enough firms have
left, and industry output falls
enough, higher prices allow
the new marginal firm to break
even, despite an upward shift
In LAC. Further incentives for
entry or exit disappears.