Perfect competition is an ideal market structure where many small firms produce identical goods, there are no barriers to entry or exit, and both buyers and sellers have perfect information. Under perfect competition in the long run, firms earn zero economic profit and both allocative and productive efficiency are achieved as price equals marginal cost and firms produce at minimum average total cost.

1. The Model of Perfect Competition

2. Perfect Competition - An IdealFirms are primarily distinguished from each other by the degree of competition they face:Perfect CompetitionMonopolistic CompetitionMonopolyOligopolyProfit maximization.The Model of Perfect Competition.Allocative and Productive efficiencies.Long-run costs and adjustments

3. Profit Maximizing RuleNo 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 CompetitionAll 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$SMCPe = MR = dPeDqQq*Qeq2q1A FirmThe MarketPerfect CompetitionMarket price = price to the firm = MR(This is the “demand” for the firm’s output & is perfectly elastic.)

6. $MCATCPeMR = dqq*A FirmPerfect CompetitionHow can we tell if a firm makes a profit?Calculate: Total Revenue = P•q*& Total Cost = ATC •q*Econ Profit = TR - TC

7. $MCATCPeMR = dqq*A FirmScenario #1 - Positive ProfitThe ATC must be less than the price, so that calculated profit is positive.What will happen in this industry in the long run?

8. $MCATCPeMR = dqq*Scenario #2 - Zero Econ ProfitThe 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. $MCATCAVCPeMR = dqq*A FirmScenario #3 - Negative Profit IThe 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$AVCMCPeMR = dqq*A FirmScenario #3 - Negative Profit II:The Shutdown PointThe firm will shut down, right away, if the Price (MR) is less than the AVC…or, if the total loss > fixed costsWhat will happen in this industry in the long run?Fixed CostsDo worksheet on perfect competition.

11. Perfect Competition & EfficiencyAllocative Efficiency (What to produce?)occurs when Price = Marginal CostWhy ?Productive Efficiency (How to produce?)occurs where output level is at the minimum ATCWhy ?

12. $MCATCPeMR = dqq*Perfect Competition & EfficiencyPerfectly competitive firms always charge a price = MC. Why?In the LR, perfectly competitive firms produce at min. ATC. Why?Perfectly competitive firms are alwaysAllocatively EfficientIn the LR, perfectly competitive firms are Productively Efficient

13. S*PPIf econ profits are positive, entry occursSSS*PePeIf econ profits are negative, exit occursDDQQQeQeThe MarketThe MarketPerfect Competition in LRWe know that in SR, firms can earn a positive, or negative, economic profit. What happens in the long run?

14. PSS*PePe*MR* = d*DQq*QeThe MarketPerfect Competition in LRIf a firm earns positive economic profit, in the long run that will be dissipated as firms enter.$MCATCMR = dPeIn the LR, this firm earns 0 econ profit.qq*A Firm

15. S*PSMR* = d*Pe*PeDQq*QeThe MarketPerfect Competition in LRIf a firm earns negative economic profit, in the long run that will be eliminated as firms exit.ATC$MCMR = dPeIn the LR, this firm earns 0 econ profit.qqA Firm

16. The Paradox of Taxing Economic ProfitIn the short run, there are no consequences!P$MCSATCMR* = d*P*Pe = MR = dPeD*DqQqQeq*A FirmThe Market