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Perfect Competition
Perfect Competition
Perfect Competition
Sellers want to sell at the highest possible price
Buyers seek lowest possible price All trade is voluntary
When economists turn their attention to differences in trading they think immediately about market structure
Characteristics of a market that influence behavior of buyers and sellers when they come together to trade 2
Perfect Competition
To determine structure of any particular market, we begin by asking
How many buyers and sellers are there in the market? Is each seller offering a standardized product, more or less indistinguishable from that offered by other sellers
Or are there significant differences between the products of different firms?
Are there any barriers to entry or exit, or can outsiders easily enter and leave this market?
Answers to these questions help us to classify a market into one of four basic types
Perfect competition Monopoly Monopolistic Oligopoly
Significant economies of scale may give existing firms a cost advantage over new entrants
Significant barriers to entry and exit can completely change the environment in which trading takes place
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Why is this?
Model of perfect competition is powerful Many marketswhile not strictly perfectly competitivecome reasonably close
We can evenwith some cautionuse model to analyze markets that violate all three assumptions Perfect competition can approximate conditions and yield accurate-enough predictions in a wide variety of markets 9
In learning about competitive firm, must also discuss competitive market in which it operates
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$400 D
$400
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15
550
Slope = 400
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MC
$400
D = MR
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A firm suffers a loss whenever P < ATC at the best level of output
Its total loss equals area of a rectangle
Height equals distance between P and ATC Width equals level of output
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MC d = MR
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MC
Loss per Ounce ($100) ATC $300 200 d = MR Ounces of Gold per Day
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Profit-maximizing output level is always found by traveling from the price, across to the firms MC curve, and then down to the horizontal axis, or
As price of output changes, firm will slide along its MC curve in deciding how much to produce
Exception
If the firm is suffering a loss large enough to justify shutting down
It will not produce along its MC curve It will produce zero units instead
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(b)
Price per
Bushel
Firm's Supply
Curve
AVC
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For all prices below $1the shutdown priceoutput is zero and the supply curve coincides with vertical axis 25
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As we move along this curve, we are assuming that two things are constant
Fixed inputs of each firm Number of firms in market
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Firm
Price per Bushel $3.50 2.50 2.00 1.00 0.50 Firm's Supply Curve Price per Bushel $3.50 2.50 2.00 1.00 0.50
2,000 4,000 7,000 Bushels per Year 5,000 2. the typical firm supplies the profit-maximizing quantity.
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Short-Run Equilibrium
How does a perfectly competitive market achieve equilibrium?
In perfect competition, market sums buying and selling preferences of individual consumers and producers, and determines market price
Each buyer and seller then takes market price as given
Each is able to buy or sell desired quantity
Added together Market Demand Curve Quantity Demanded by All Consumers at Different Prices
Added together Quantity Supplied by All Firms at Different Prices Market Supply Curve
Market Equilibrium
P S D Q
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2. the typical firm operates here, earning economic profit in the short run.
Firm
2.00 D2
D1
400,000 700,000 per Year 3. If the demand curve shifts to D2 and the market equilibrium moves here . . .
Bushels
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In a competitive market, positive economic profit continues to attract new entrants until economic profit is reduced to zero
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MC A d ATC 1
$4.50
900,000
9,000
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Firm
2.50
d1
Bushels per Year
per Year
5,000
9,000
until market price falls to $2.50 and each firm earns zero economic profit.
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In a competitive market, economic losses continue to cause exit until losses are reduced to zero When there are no significant barriers to exit
Economic loss will eventually drive firms from the industry
Raising market price until typical firm breaks even again
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When economists look at a market, they automatically think of short-run versus longrun
Choose the period more appropriate for question at hand
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Same opportunity to earn positive economic profit will attract new entrants that will establish larger plants from the outset
Entry and expansion must continue in this market until the price falls to P*
Because only then will each firmdoing the best that it can do earn zero economic profit
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3. As all firms increase plant size and output, market price falls to its lowest possible level . . .
Dollars LRATC
P1 P*
2. The firm could earn positive profit with a Output per 4. and all firms earn q1 larger plant, q* Period producing here. zero .economic profit and produce at minimum LRATC.
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In figure 9(b), this equality is satisfied when the typical firm produces at point E
Where its demand, marginal cost, ATC, and LRATC curves all intersect
In perfect competition, consumers are getting the best deal they could possibly get
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A Change in Demand
Short-run impact of an increase in demand is
Rise in market price Rise in market quantity Economic profits
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Market
S1
Dollars
Firm
MC ATC1
P1
P1
d1 = MR1
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Market
S1 B S2 SLR
Dollars PSR
Firm
B C MC ATC2 ATC1d = MR 2 2 d1 = MR1
dSR = MRSR
P2 P1
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Decreasing cost industry, in which entry by new firms actually decreases input prices
Entry causes input prices to fall
Causes typical firms ATC curve to shift downward Lowers market price at which firms earn zero economic profit As a result, long-run supply curve slopes downward
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In long-run, economic profit at this farm will cause two things to happen
All other farms in market will have a powerful incentive to adopt new technologyto plant the new, genetically engineered seed themselves Outsiders will have an incentive to enter this industry with plants utilizing the new technology
Shifting market supply curve rightward and driving down the market price
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Firm
S2
A
$3
Q1
Q2
1000
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