1. Perfect Competition
Many buyers & sellers (no individual has mkt power)
Homogeneous product – no branding or differentiation
Perfect information – consumers always know what’s on offer for what prices
Freedom of entry & exit – no “barriers to entry”
So… firms are price takers.

2. The Demand Curve in Perfect Competition
Since the firm is a price taker and an insignificant part of the total market, the individual firm has no control over the price it can charge, but it can sell as much as it wants at that price. The demand curve, therefore will be “perfectly elastic” (horizontal) at the market price.
Since this demand curve has the same price (average revenue) at all quantities, AR will be equal to MR.

3. Perfect Competition – Cost Curves
Individual Firm
Market
Price £
Price £ MC S
AR = MR
Mkt Price D
Qpm
Quantity
Quantity
Price is determined in the market – firms can sell as much as they like at this price.

4. Perfect Competition – Short Run / Long Run
Individual Firm
Market
Price £
Price £ S MC AC
Mkt Price
AR = MR
Supernormal Profits D
Qpm
Quantity
Quantity
If, in the short run, if mkt price is above AC, firms can earn supernormal profits – this attracts more firms into the industry

5. Perfect Competition – Short Run / Long Run
Individual Firm – short run
Market
Individual Firm – long run S
AC1 MC S1 AC
MC1 P P1
AR = MR
AR1 = MR1 D
Qpm
Qpm Q Q Q
In the short run, if price is above AC, firms earn supernormal profits – this attracts firms into the industry, lowering price and eroding supernormal profits back to normal profits in long run.

6. Perfect Competition – short run / long run
Individual Firm
Market
Price £
Price £ MC AC S
Loss
Mkt Price
AR = MR D
Qpm
Quantity
Quantity
If, in the short run, mkt price is below ave. cost, firms can make losses – this leads firms to leave the industry

7. Perfect Competition – short run / long run
Individual Firm – short run
Market
Individual Firm – long run MC
MC1 AC
AC1 S1 S P
AR1 = MR1
AR = MR D
Qpm Q
Qpm Q Q
If, in the short run, mkt price is below ave. cost, firms can make losses – this leads firms to leave the industry, raising price and profits back to the “normal” level for remaining firms.

8. Perfect Competition – Long Run
Individual Firm
Market
Price £
Price £ MC AC S
AR = MR
Mkt Price D
Quantity
Quantity

9. Perfect competition – shut down point
Individual Firm
Market
Price £
Price £ MC
SRATC S
SRAVC
Mkt Price
AR = MR D
Quantity
Quantity
This firm is making a loss. But they will continue producing in the short run because P ˃ SRAVC.

10. Perfect competition – shut down point
Individual Firm
Market
Price £
Price £ MC
SRATC S
SRAVC
Mkt Price
AR = MR D
Quantity
Quantity
This firm is making a loss. They will shut down because P ˂ SRAVC.
*Shut down point is where P = SRAVC*

11. Let’s think about what the firm’s supply curve might look like…
(not on the spec… just interesting)

12. Perfect Competition Efficiency
Allocative Efficiency 
Since P = MR, and the firm will produce where MR = MC, then MC = P
Productive Efficiency 
In the long run, production will settle at the min. AC.
In the short run, not producing at min AC
Dynamic Efficiency
Producers will strive to keep up with each other so as to make normal profit at the market price

13. equal access
insignificant
homogeneous
no costs
complete information
costless
barriers to entry/exit
competition
Price taker

14. Evaluating the Perfect Competition Model
Strong assumptions are made about - homogeneity of product - absence of sunk costs - freedom of entry/exit - complete information being available
This “perfect” situation rarely exists