Perfect Competition

Objectives By the end of this lesson you should be able to… Define Perfect Competition Explain 2 characteristics of the Perfect Competition model Explain why, in the Perfect Competition model, P=AR=D for a firm Explain the long run equilibrium diagram

Starter Mr M’s Perfectly Competitive Carrots! Round 1 Students take a carrot each for their market stall. Teacher buys a carrot from each stall and puts them in shopping bag Once all the carrots have been bought the teacher takes them back to the students (sellers) and asks them to take back their carrot Students are unable to distinguish their carrots from the others Homogenous product Round 2 Students take a carrot each for their market stall Teacher asks how much will you sell me you carrot for? Will only buy from cheapest provider Having decided what he is prepared to pay the teacher will then only buy carrots that are at or below that price Students pricing should affected by what they hear and their prices should start to converge Illustrates perfect knowledge

In your notes quickly draw a spider diagram of the key characteristics of market structure

Market Structure characteristics Degree of power of each firm EoS Sunk costs Legal Limit pricing Anti-comp practices Barriers to entry / exit Market concentration Number of firms Products differentiated from competition – easier to control Perfect Knowledge – every firm has access to the same info Market Structure characteristics Knowledge/ Information Product homogeneity / branding Profit levels New firms (entrants) attracted by abnormal profits

Market Structure More competitive (fewer imperfections) Perfect Competition Pure Monopoly More competitive (fewer imperfections)

Less competitive (greater degree of imperfection) Market Structure Perfect Competition Pure Monopoly Less competitive (greater degree of imperfection)

Monopolistic Competition Market Structure Pure Monopoly Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly The further right on the scale, the greater the degree of monopoly power exercised by the firm.

So Perfect Competition Is a model of an extreme market structure Which is based on certain assumptions

Basic Assumptions Many small sellers each of whom produces an insignificant percentage of total market output and thus exercise no control over the market price Many individual buyers – no control over the market price No barriers to entry/ exit Homogenous product – perfect substitutes. This leads to firm being passive ‘price takers’ and facing a perfectly elastic demand curve for their product. No externalities arising from production and/or consumption which lie outside the market Externalities – those costs or benefits which occur as a result of the main operation of a business but which ar not part of the firm’s profit and loss account. E.g. pollution and congestion – costs which are borne by the community not the business.

Many small firms The firm’s demand curve is perfectly e l a s t i c because any firm that raises its prices sees demand fall to zero as consumers, with perfect knowledge, switch to other producers offering an identical product for a better price each of whom produces an insignificant percentage of total market output and thus exercise no control over the market price Price takers…so small and so many – individual firms cannot influence price P S P P = D = AR D O O Q Q Industry Firm

Homogenous goods/services Products perceived to be identical Perfect substitutes Consumers buy from cheapest provider Each firm is a passive price taker Firms face perfectly e l a s t i c demand curve for its product

Perfect Information Consumers have readily available info about the market – prices and products from competing suppliers Can access info at zero cost Few transaction costs involved in searching for price info

Freedom of entry and exit No barriers to entry /exit No sunk costs Entry and exit from the market feasible in the long run If firms are making abnormal profits, new firms can easily enter the market This assumption ensures all firm make normal profits in the long run

Your go… Taking the characteristics of perfect competition insert ticks to express the degree to which each of the markets displays them…

Real examples of Perfect Competition – FX Market Currency markets – taking us closer to perfect competition Global FX markets are where all buying and selling of world currencies takes place. 24x5 trading $4 trillion daily trade value vs New York Stock Exchange: $37bln $4,000,000,000,000 vs. $37,000,000,000

Why does a currency market come close to perfect competition? Homogenous product – a dollar is a dollar, a pound a pound, wherever you trade it Many buyers and sellers – all are price takers High quality real-time info and low transaction costs Electronic trading allows buyers and sellers to deal only with those who offer the best prices Thomson Reuters datafeed service delivers price data from the exchange to your office in under a millisecond….1/1000th of a second!

Other examples Commodity markets Softs - grown Wheat, coffee, sugar, cocoa, rice Hards – extracted through mining Metals Gold Oil

You will need to reproduce diagrams In an essay or Data Response Need to consider both the individual firm and the market (industry) Investigate firm’s output, price, revenue and profit in both the short and the long run Start with the long run…

Long run equilibrium Industry Firm MR=MC Maximum profits MC AC P S P Before we look at the market dynamics, lets first understand what the end state looks like… MR=MC Maximum profits MC AC P S P P = D = AR = MR P1 D O O Q Q1 Q Industry Firm

To recap What are the characteristics of Perfect Competition? Do firms in perfectly competitive markets make a loss? What would the concentration ratio be for a perfectly competitive industry? Why is Perfect Competition rare in reality?

Homework...by tomorrow! Learn the characteristics of Perfect Competition Read article: ‘Perfect Competition’ – Does it exist, and does it matter?

Plenary By the end of this lesson you should be able to… Define Perfect Competition Explain 2 characteristics of the Perfect Competition model Explain why, in the Perfect Competition model, P=AR=D for a firm Explain the long run equilibrium diagram