Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Perfect competition

16,078 views

Published on

Published in: Education

Perfect competition

  1. 1. Market Structures
  2. 2. Perfect Competition• It is a theoretical model.
  3. 3. • Assumptions:• Large number of firms.
  4. 4. • Assumptions:• Individual firms are “price takers”.
  5. 5. • Assumptions:• Homogeneous products.
  6. 6. • Assumptions:• Freedom of entry and exit.
  7. 7. • Assumptions:• Perfect knowledge of the market.
  8. 8. 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.
  9. 9. Profit maximization for the firm in perfect competition• Profit maximization rule: MC=MR• For a firm, P=D=AR=MR
  10. 10. Short run abnormal profit in perfect competition• Firms are more than covering their total cost, including opportunity cost.
  11. 11. 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.
  12. 12. Short-run loss in perfect competition• Firms are not covering their total cost.
  13. 13. 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)
  14. 14. 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.
  15. 15. 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.
  16. 16. 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
  17. 17. 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.
  18. 18. Profitmaximization •MC=MR Productive efficiency •MC=AC Allocative efficiency •MC=AR
  19. 19. 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)
  20. 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. 21. 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.
  22. 22. Examples of perfect competition:– Financial markets – stock exchange, currency markets, bond markets?– Agriculture?
  23. 23. Advantages of Perfect Competition:High degree of competition helps allocate resources to most efficient usePrice = marginal costsNormal profit made in the long runFirms operate at maximum efficiencyConsumers benefit

×