Perfect Competition

1. The Model of Perfect Competition

2. Perfect Competition - An Ideal Firms are primarily distinguished from each other by the degree of competition they face: Perfect Competition Monopolistic Competition Monopoly Oligopoly Profit maximization. The Model of Perfect Competition. Allocative and Productive efficiencies. Long-run costs and adjustments

3. Profit Maximizing Rule No matter what kind of firm we are talking about, they will max. profit when:Marginal Revenue = Marginal Cost (MR) (MC) If MR > MC, you are foregoing profit. If MR < MC, you are foregoing profit.

4. Perfect Competition All goods are identical.--One cannot be (usefully) distinguished from another. Many buyers and sellers.--No one can affect price through their actions. There are no barriers to entry/exit.--Firms cannot earn economic profit in the long run. Buyers & sellers have perfect information.--A single price will prevail in the market.

5. P $ S MC Pe = MR = d Pe D q Q q* Qe q2 q1 A Firm The Market Perfect Competition Market price = price to the firm = MR(This is the “demand” for the firm’s output & is perfectly elastic.)

6. $ MC ATC Pe MR = d q q* A Firm Perfect Competition How can we tell if a firm makes a profit? Calculate: Total Revenue = P•q*& Total Cost = ATC •q* Econ Profit = TR - TC

7. $ MC ATC Pe MR = d q q* A Firm Scenario #1 - Positive Profit The ATC must be less than the price, so that calculated profit is positive. What will happen in this industry in the long run?

8. $ MC ATC Pe MR = d q q* Scenario #2 - Zero Econ Profit The ATC must be equal to the price, so that calculated profit is zero. What will happen in this industry in the long run? A Firm

9. $ MC ATC AVC Pe MR = d q q* A Firm Scenario #3 - Negative Profit I The ATC must be more than the price, so that calculated profit is negative. Will this firm stay in business in the short run?It depends . . . What will happen in this industry in the long run?

10. ATC $ AVC MC Pe MR = d q q* A Firm Scenario #3 - Negative Profit II:The Shutdown Point The firm will shut down, right away, if the Price (MR) is less than the AVC…or, if the total loss > fixed costs What will happen in this industry in the long run? Fixed Costs Do worksheet on perfect competition.

11. Perfect Competition & Efficiency Allocative Efficiency (What to produce?) occurs when Price = Marginal Cost Why ? Productive Efficiency (How to produce?) occurs where output level is at the minimum ATC Why ?

12. $ MC ATC Pe MR = d q q* Perfect Competition & Efficiency Perfectly competitive firms always charge a price = MC. Why? In the LR, perfectly competitive firms produce at min. ATC. Why? Perfectly competitive firms are alwaysAllocatively Efficient In the LR, perfectly competitive firms are Productively Efficient

13. S* P P If econ profits are positive, entry occurs S S S* Pe Pe If econ profits are negative, exit occurs D D Q Q Qe Qe The Market The Market Perfect Competition in LR We know that in SR, firms can earn a positive, or negative, economic profit. What happens in the long run?

14. P S S* Pe Pe* MR* = d* D Q q* Qe The Market Perfect Competition in LR If a firm earns positive economic profit, in the long run that will be dissipated as firms enter. $ MC ATC MR = d Pe In the LR, this firm earns 0 econ profit. q q* A Firm

15. S* P S MR* = d* Pe* Pe D Q q* Qe The Market Perfect Competition in LR If a firm earns negative economic profit, in the long run that will be eliminated as firms exit. ATC $ MC MR = d Pe In the LR, this firm earns 0 econ profit. q q A Firm

16. The Paradox of Taxing Economic Profit In the short run, there are no consequences! P $ MC S ATC MR* = d* P* Pe = MR = d Pe D* D q Q q Qe q* A Firm The Market