2. Market Structures

3. Perfect Competition
• It is a theoretical model.

4. • Assumptions:
• Large number of firms.

5. • Assumptions:
• Individual firms are “price takers”.

6. • Assumptions:
• Homogeneous products.

7. • Assumptions:
• Freedom of entry and exit.

8. • Assumptions:
• Perfect knowledge of the market.

9. Demand curves for industry and firm
in perfect competition
• Industry:
• Normal demand and supply
curves.
• More supply at higher price and
less demand and higher price.
• Firm:
• Price takers.
• Have to accept the industry price.

10. Profit maximization for the firm in
perfect competition
• Profit maximization rule: MC=MR
• For a firm, P=D=AR=MR

11. Short run abnormal profit in perfect
competition
• Firms are more than covering their total cost,
including opportunity cost.

12. Short-run abnormal profit to long-run
normal profit
 Short-run abnormal profit attracts
more firms to the
industry.(Freedom of entry)
 Supply curve shifts to the right.(S
to S1)
 This pulls down the price. (P to P1)
 Demand curve shifts downwards.
(D to D1)
 At new price, P= C
 In the long-run there is no
abnormal profit.

13. Short-run loss in perfect competition
• Firms are not covering their total cost.

14. Short-run losses to log-run normal
profit
• Due to losses, a few firms
will leave the
industry.(Freedom of
exit)
• Supply curve shifts to the
left.(S to S1)
• Industry price begin to
rise.(P to P1)
• Demand curve shifts
upwards.(D to D1)
• At new price, P=C
(normal profit)

15. Long-run equilibrium
• In the long-run, firms in
perfect competition can
make only normal profit.
• Freedom of entry and exit
eliminates the short-run
abnormal profit and short-
run losses.
• In the long-run equilibrium,
there is no incentive for
firms to enter or leave the
industry.

16. Productive and allocative efficiency
• Productive efficiency:
• A firm is productive
efficient when it produces
at its lowest possible unit
cost(average cost)
• MC=AC
• This means the
combination of resources
is efficient and there no
wastage of resources.

17. Productive and allocative efficiency
• Allocative Efficiency:
• This is socially optimum
level of output.
• Producers are
producing the optimal
mix of goods and
services required by
consumers.
• Price reflects the value
that consumers place
on a good.
• MC=AR Cost to The value to
producers consumers

18. Pareto Optimality
• Allocative efficiency means there is Pareto
optimality.
• Situation where it is impossible to make one
person better off without making someone
else worse off.
• An economic state where resources are
allocated in the most efficient manner.

19. Profit
maximization •MC=MR
Productive
efficiency •MC=AC
Allocative
efficiency •MC=AR

20. Productive and allocative efficiency in
the short run in perfect competition
• Profit maximization level
of output is at
q(MC=MR)
• Allocative efficiency is at
q2 (MC=AR)
• Productive efficiency is
at q1 (MC=AC)

21. Productive and allocative efficiency in
the short run in perfect competition
• Profit maximization level
of output is at q(MC=MR)
• Allocative efficiency is at
q2 (MC=AR)
• Productive efficiency is at
q1 (MC=AC)

22. Productive and allocative efficiency in
the long run
• In the long run, Profit
maximization level of
output=productive
efficiency=allocative
efficiency.
• This is because, there is
perfect knowledge and
same cost curves.

23. Examples of perfect competition:
– Financial markets – stock exchange,
currency markets, bond markets?
– Agriculture?

24. Advantages of Perfect
Competition:
High degree of competition helps allocate resources to most efficient use
Price = marginal costs
Normal profit made in the long run
Firms operate at maximum efficiency
Consumers benefit