Perfect Competition Economic Theory of Free Markets

Perfect Competition Monopolistic Competition Oligopoly Monopoly economic theory/model => Unlimited # of competitors Most competitive & Lowest Price Least competitive & Highest Price 4 Market Structures 1 company => PGE, local water company 3-10 large companies Car companies, airlines, Wireless service, smart phones Many Companies Restaurants, hair salons, Bicycle shops, car repair

Market Characteristics 4 market characteristics: –# of Firms –Type of Product –Ease of entering or exiting industry –Amount of Information Determine pricing control of each market structure

Perfect Competition Perfect Competition is an economic theory/model – “built” by economists to simulate a “perfect” self regulating economy It does not exist in the “real” world –The market for wheat & corn is close It produces the lowest price & highest quantity of all market structures

Perfect Competition Market Characteristics Many/Unlimited small Firms Homogenous products (exactly the same!) Complete freedom to enter or exit industry –No costs to move, occurs immediately Perfect information Price Taker: –No price control—sell at Market Price

Perfect Competition Equilibrium Price Qty T-Shirts D1D1 S1S $10 Q1Q1 E1E1 Price Qty A small firm can sell all of their production at the market price (price taker) $10 Entire Industry1-Individual Firm D1D1 T-Shirts

“Zero” Economic Profit Competitive markets can earn profit or loss in the short run In long run profits are pushed to zero economic profit –It means you earn a “normal/fair” economic profit i.e. includes the Opportunity Cost of working You still earn a “fair living” based on your human capital

Perfect Competition in “Action” The market is naturally “self-regulating” New firms will enter the market as if economic profit > zero –Due to easy & cheap entry/exit Firms exit the market whenever profits are less than zero Firms move between industries in search of higher profit In long run, inefficient producers are forced to leave & economic profit falls to zero (normal or fair profit level)

Worksheet

T-SHIRTS Profit = 100 day BICYCLES Profit = 200 day FOOD Profit = 100 day The Self-Regulation of Perfect Competition S1S1 D1D1 S1S1 D1D1 S1S1 D1D P1P1 P1P Q1Q1 E1E1 Q1Q1 Q1Q1 E1E1 Q1Q1 E1E1 P1P1 S2S2 S2S2 Firms exit market Firms exit market S2S2 Firms enter market Firms: exit markets with low profits enter markets with high profits In long run, all firms will earn zero economic profit In this example, assume $150 per day accounting profit