Perfect Competition Chapter 14

Market Structures Market Structure is the way an industry is organized: Auto Industry versus Restaurant Industry

4 Market Structures “I hate Monopolies” Perfect Competition is only an economic theory/model. It does not exist in the “real” world It would be Adam Smith’s dream! Perfect Competition Monopolistic Competition Monopoly Oligopoly Most competitive Least competitive

All firms can earn economic profit in the short run All firms maximize profit when MR = MC Some firms must earn zero economic profit in long run Costs $3.00 2.50 MC ATC AVC AFC 2.00 1.50 1.00 0.50 2 4 6 8 10 12 14 Quantity of Output

Market Characteristics 4 market characteristics of an industry determine the pricing power of a business 5 market characteristics: # of Firms Type of Product Ease of entering or exiting industry Amount of Information Degree of Price Control Determine degree of price control

Perfect Competition Characteristics Many small Firms Homogenous products Complete freedom to enter or exit industry No cost, immediate action Perfect information Price Taker: No price control—sell at Market Price

Perfect Competition in “Action” All firms are small & can quickly enter/exit industry No costs, immediate action The actions of any single buyer/seller have a negligible impact on market price Each buyer & seller takes current market price of output (price taker) Competitive firms move to any industry with more economic profit short run: Firms can earn profit by setting MR = MC long run: All firms must earn zero economic profit (MR=MC) Market is naturally “self-regulating” Excess profit cannot last => new firms enter market => price falls!

Perfect Competition Equilibrium Entire Industry Individual Firm T-Shirts T-Shirts Price S1 Price MC P = MR $10 -------------- E1 $10 D1 ------------- Q1 E1 ------------- D1 Q1 Qty Qty Individual firms can sell all their production at current Market Price

Revenue of a Competitive Firm In Perfect Competition P = AR = MR Average Revenue (AR =TR/Q) Marginal Revenue (MR =TR/Q)

Worksheet

Zero Economic Profit Does not mean zero accounting profit Means you earn a “normal” economic profit Also includes all Implicit Costs Such as the Opportunity Cost of working Profits can not stay above zero in a competitive market In long run profits are pushed to zero

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

Competitive Market Entire Industry Individual Firm S1 MC T-Shirts T-Shirts Price S1 Price MC $15 -------------- E1 $15 D1 = MR E1 ------------- ---------------- D1 Q1 Qty Q1 Qty

Market Characteristics Perfect Competition # Sellers Type of Product Ease of Entry/Exit Information Price Control

Perfect Competition Video http://www.youtube.com/watch?v=8IDK_37fAMs