1. PERFECT COMPETITION Chpt 12

2. Overview market structure describes the state of a market with respect to competition.market The major market forms are: ◦Perfect competition, in which the market consists of a very large number of firms producing a homogeneous product.Perfect competition ◦Monopolistic competition, also called competitive market, where there are a large number of independent firms which have a very small proportion of the market share.Monopolistic competition ◦Oligopoly, in which a market is dominated by a small number of firms which own more than 40% of the market share.Oligopoly ◦Oligopsony, a market dominated by many sellers and a few buyers.Oligopsony ◦Monopoly, where there is only one provider of a product or service.Monopoly ◦Natural monopoly, a monopoly in which economies of scale cause efficiency to increase continuously with the size of the firm.Natural monopolyeconomies of scale ◦Monopsony, when there is only one buyer in a market.Monopsony 2

3. Overview of Market Structures Quick Reference to Basic Market Structures Market StructureSeller Entry Barriers# of SellersBuyer Entry Barriers# Buyers Perfect CompetitionNoManyNoMany Monopolistic competitionNoManyNoMany Oligopoly (few firms)YesFewNoMany Oligopsony (few buyers)NoManyYesFew Monopoly (one firm)YesOneNoMany Monopsony (one buyer)NoManyYesOne 3

4. Basic Assumptions: Perfect Competition Atomicity ◦There is a large number of small producers and consumers on a given market, ◦each so small that its actions have no significant impact on others. ◦Firms are price takers, meaning that the market sets the price that they must choose.price takers Homogeneity ◦Goods and services are perfect substitutes; that is, there is no product differentiation. (All firms sell an identical product) Perfect and complete information ◦All firms and consumers know the prices set by all firms Equal access ◦All firms have access to production technologies, and resources are perfectly mobile. Free entry ◦Any firm may enter or exit the market as it wishes (no barriers to entry).barriers to entry Individual buyers and sellers act independently ◦The market is such that there is no scope for groups of buyers and/or sellers to come together to change the market price (collusion and cartels are not possible under this market structure) Behavioral assumptions of perfect competition are that: ◦Consumers aim to maximize utility/well-being ◦Producers aim to maximize profits. 4

5. What is a Competitive Market? Competitive market ◦Market with many buyers and sellers ◦Trading identical products ◦Each buyer and seller is a price taker ◦Firms can freely enter or exit the market Implying ◦No firm or individual has any “market power” ◦No ability to set or effect market equilibrium price 5

6. Profit Maximizing Rule Quantity (Q) ◦ How many driveways did Mr. Plow clear? Price (P) ◦ Price charged per driveway Total Revenue (TR) ◦ TR = P  Q Total Costs (TC) ◦ Sum of all production costs at a certain level of output Profit (π) ◦ π = TR – TC

7. Profit Maximizing Rule Marginal Revenue (MR) ◦ MR = ΔTR ÷ ΔQ ◦ Δ = change in ◦ For a competitive firm, MR = P Marginal Cost (MC) ◦ MC = ΔTC ÷ ΔQ ◦ Additional costs of producing additional units

8. Profit Maximizing Rule Change in Profit ◦ ΔProfit = MR – MC Profit maximizing rule: ◦ To maximize profits, the firm should use a marginal analysis ◦ Profit is maximized by choosing the level of output such that MR = MC

9. Profit Maximizing Rule Profit is maximized by choosing the level of output such that MR = MC If MR > MC ◦ The firm can increase profits by producing more Q If MR < MC ◦ The firm has produced “too much” Q, and profits are not maximized