Perfect Competition content slideshow. Designed for the Economics A level qualification. Can be used in revision and in class. Subtopics: Intro to Perfect Competition Equilibria of Perfect Competition Market Shocks in Perfect Competition Evaluating Perfect Competition

1. Perfect
Competition
Upper 6th Micro
Market Structures

2. Intro to
Perfect
Competition
Perfect Competition
Mr O’Grady

3. Intro to Perfect Competition
Definition: A perfectly competitive market is a hypothetical market where competition is
at its greatest possible level.
Assumptions:
Many buyers, many sellers: No individual firm or customer is large enough to have any
market power
Therefore all firms are price takers (Firms accept the prevailing market price, horizontal AR curve)
No entry or exit barriers: Whenever there is profit to be made, firms are able to enter
the market and establish themselves quickly and cheaply
Firms can also exit the industry without cost (i.e. no sunk costs) and they are assumed to have
perfectly mobile factors of production
There is also equal access to technology (links to perfect knowledge)
Homogeneous goods: Identical goods, without branding or advertising – perfect
substitutes
All goods are exactly the same
Perfect information: Every buyer always knows the prices that all firms are charging
Can easily find the lowest possible price and therefore buy from the cheapest supplier
Again, this means all firms are price takers
Profit maximisation: All firms operate at MR = MC
Although in the long run, this will only provide them with normal profits

4. Equilibria of
Perfect
Competition
Perfect Competition
Mr O’Grady

5. Outcomes of Perfect Competition
Short run equilibrium: Firms can make supernormal profits (green rectangle) as
the market price is above the firm’s average cost (other SR equilibrium can exist)
All firms individually produce at the point where their individual MC meets the MR
curve (q).
Each firm sells at the same price (p) but each individual firm’s q will vary based on their costs
Allocatively efficient (P = MC), but Productively inefficient (c > AC min)
There could be dynamic efficiency (firms have supernormal profits to spend on R&D)
D
S
Quantity
Price Market Firm
P
Q
D = AR
= MR
Quantity
C/R
p
q
c
AC
MC

6. Outcomes of Perfect Competition
Long run equilibrium: Firms can only make normal profits as the market price falls to the
minimum point of the firm’s average cost
The profits made in the short run attracts new firms to join the market increasing supply,
cutting market price.
This continues until all firms are selling at the lower price P1, the lowest point of their AC curves,
making only normal profits into the long run
No more firms want to join as they’d make a loss (market price would fall below min AC)
Allocatively efficient (P1 = MC at q1), Productively efficient (q1 occurs at AC min) and there is no X-
inefficiency (firms would make losses and leave the market if their LRAC wasn’t minimised)
Dynamically inefficient (no profits to pay for R&D and innovation)
D
S
Quantity
Price Market Firm
P
Q
D = AR
= MR
Quantity
C/R
p
q
c
AC
MC
D
S S1
Quantity
Price Market Firm
P1
Q
D1 = AR1 =
MR1
D = AR= MR
Quantity
C/R
q1
p1/c1
P
p
qQ1
AC
MC

7. Market Shocks
in Perfect
Competition
Perfect Competition
Mr O’Grady

8. Market Shocks in Perfect Competition
Analysis: Shocks to either supply or demand will affect the market price
Changes to market price will effect firms’ profits (or losses) and incentivise firms to either
enter or leave the market
From assuming a start at the long run equilibrium we can analyse the impacts of market
shocks
D
S
Quantity
Price Market Firm
P
Q
D = AR = MR
Quantity
C/R
p/c
q
AC
MC

9. Example 1: A fall in market demand
Short run: The fall in demand means the market price is now below the minimum average
costs firm can operate at.
Firms now make a loss (pink rectangle)
D
S
Quantity
Price Market Firm
P
Q
D = AR = MR
Quantity
C/R
p/c
q
AC
MC
DD1
S
Quantity
Price Market Firm
P
Q
D1 = AR1 = MR1
Quantity
C/R
q
P1
q1
p1
c1
Q1
AC
MC

10. Example 1: A fall in market demand
Short run: The fall in demand means the market price is now below the minimum average
costs firm can operate at.
Firms now make a loss (pink rectangle)
Long run: some of the loss making firms leave the market, reducing the supply of the good.
Falling supply increases prices
This continues until the remaining firms make normal profit again
D
S
Quantity
Price Market Firm
P
Q
D = AR = MR
Quantity
C/R
p/c
q
AC
MC
DD1
S
Quantity
Price Market Firm
P
Q
D1 = AR1 = MR1
Quantity
C/R
q
P1
q1
p1
c1
Q1
AC
MC
DD1
S
S2
Quantity
Price Market Firm
P
Q
D2 = AR2 = MR2
Quantity
C/R
q
P1
p/c
Q2 Q1
AC
MC

11. Example 2: An increase in market demand
Short run: The rise in demand means the market price is now above the minimum average
costs firm can operate at.
Firms can now make a supernormal profit (green rectangle)
D
S
Quantity
Price Market Firm
P
Q
D = AR = MR
Quantity
C/R
p/c
q
AC
MC
D
D1
S
Quantity
Price Market Firm
P
Q1
D1 = AR1
= MR1
Quantity
C/R
c1
q
p1
q1
P1
Q
AC
MC

12. Example 2: An increase in market demand
Short run: The rise in demand means the market price is now above the minimum average
costs firm can operate at.
Firms can now make a supernormal profit (green rectangle)
Long run: the presence of profits in the market attracts new firms, increasing supply
Rising supply cuts prices
This continues until the firms make only normal profit again, and no new firms wish to join
D
S
Quantity
Price Market Firm
P
Q
D = AR = MR
Quantity
C/R
p/c
q
AC
MC
D
D1
S
Quantity
Price Market Firm
P
Q1
D1 = AR1
= MR1
Quantity
C/R
c1
q
p1
q1
P1
Q
AC
MC
D
D1
S
S2
Quantity
Price Market Firm
P
Q
D2 = AR2 =
MR2
Quantity
C/R
q q1
P1
Q1 Q2
AC
MC

13. Evaluating
Perfect
Competition
Perfect Competition
Mr O’Grady

14. Evaluating Perfect Competition
Rationale: Perfect Competition is a hypothetical market structure that doesn’t
really exist in practice
This is because it based on some pretty extreme assumptions
Assumption 1: Many buyers and sellers
Rarely will there ever be so many firms in a market that none have any price setting power
Assumption 2: No barriers to entry and exit
Obstacles to entry like patents, intellectual property laws, tight control of key inputs are
common in the real world but all ignored by the perfectly competitive model
Some sunk costs, such as search costs, are impossible to avoid even with the spread of low-
cost digital/web technology platforms
Rare for entry and exit in an industry to be costless – there are very few industries that are
perfectly contestable
Assumption 3: Homogenous goods
Goods are often similar but rarely do multiple firms simultaneously produce goods that are
perfectly identical
In the real world markets are often dominated by differentiated / branded products (non-
price competition). No rational firm would not try to differentiate

15. Assumption 4: Perfect information
There are always information gaps facing consumers, especially for highly complex products
Even for simple products do consumers ever really know everything about them
This means consumers can’t be perfectly rational and are often be influenced by advertising
Key Question: Why do we still care about perfectly competitive markets if they
don’t really exist?
Firstly, some markets are quite close to perfect competition. Many primary and commodity
markets, such as coffee and tea, exhibit many of the characteristics of perfect competition,
such as the number of individual producers that exist, and their inability to influence market
price.
Secondly, for other markets in manufacturing and services, the model is a useful yardstick by
which economists and regulators can evaluate levels of competition that exist in real markets.

16. Where next?
Visit our website: www.smootheconomics.co.uk
Find more resources, enrichment materials,
details of courses, competitions, and more!
Find Our socials:
YouTube: Smooth Economics
Instagram: @smootheconomics
Twitter: @SmoothEconomics
Facebook: @SmoothEconomics