1. Perfect Competition Economic Theory of Free Markets

2. 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

3. 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

4. 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

5. 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

6. Perfect Competition Equilibrium Price Qty T-Shirts D1D1 S1S1 -------------- ------------- $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

7. “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

8. 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)

9. Worksheet

10. T-SHIRTS Profit = 100 day BICYCLES Profit = 200 day FOOD Profit = 100 day The Self-Regulation of Perfect Competition S1S1 D1D1 S1S1 D1D1 S1S1 D1D1 ------- P1P1 P1P1 -------- 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