Laugher Curve
Q. How many economists does it take
to screw in a light bulb?
A. Eight.
One to screw it in and seven to hold
everything else constant.
Perfect Competition
Market Demand vs. Individual Demand
A Perfectly Competitive
Market
Perfect Competition
z
The concept of competition is used in
two ways in economics.
Competition as a process is a rivalry
among firms.
z Competition as the perfectly competitive
market structure.
z
z
A perfectly competitive market is
one in which economic forces operate
unimpeded.
1
A Perfectly Competitive
Market
z
A perfectly competitive market must
meet the following requirements:
The Necessary Conditions
for Perfect Competition
z
A price taker is a firm or individual who
takes the market price as given.
z In most markets, households are price
takers – they accept the price offered in
stores.
z
Both buyers and sellers are price
takers.
z The number of firms is large.
z There are no barriers to entry.
z The firms’ products are identical.
z There is complete information.
z Firms are profit maximizers.
z
The Necessary Conditions
for Perfect Competition
z
Both buyers and sellers are price
takers.
z
z
The retailer is not perfectly competitive.
A retail store is not a price taker but
a price maker.
Both buyers and sellers are price
takers.
The Necessary Conditions
for Perfect Competition
z
The number of firms is large.
Large means that what one firm does
has no bearing on what other firms do.
z Any one firm's output is minuscule when
compared with the total market.
z
2
The Necessary Conditions
for Perfect Competition
z
There are no barriers to entry.
The Necessary Conditions
for Perfect Competition
z
There are no barriers to entry.
z
Barriers to entry are social, political,
or economic impediments that prevent
other firms from entering the market.
z Barriers sometimes take the form of
patents granted to produce a certain
good.
Technology may prevent some firms
from entering the market.
z
Social forces such as bankers only
lending to certain people may create
barriers.
The Necessary Conditions
for Perfect Competition
The Necessary Conditions
for Perfect Competition
z
z
The firms' products are identical.
z
This requirement means that each firm's
output is indistinguishable from any
competitor's product.
z
There is complete information.
Firms and consumers know all there is
to know about the market – prices,
products, and available technology.
z Any technological breakthrough would
be instantly known to all in the market.
z
3
The Necessary Conditions
for Perfect Competition
z
Firms are profit maximizers.
The Definition of Supply and
Perfect Competition
z
The goal of all firms in a perfectly
competitive market is profit and only
profit.
z The only compensation firm owners
receive is profit, not salaries.
z
The Definition of Supply and
Perfect Competition
z
Supply is a schedule of quantities of
goods that will be offered to the
market at various prices.
If all the necessary conditions for
perfect competition exist, we can talk
formally about the supply of a
produced good.
The Definition of Supply and
Perfect Competition
z
When a firm operates in a perfectly
competitive market, it’s supply curve
is that portion of its short-run
marginal cost curve above average
variable cost.
4
Demand Curves for the Firm
and the Industry
The demand curves facing the firm is
different from the industry demand
curve.
z A perfectly competitive firm’s demand
schedule is perfectly elastic even
though the demand curve for the
market is downward sloping.
z
Demand Curves for the Firm
and the Industry
z
Individual firms will increase their
output in response to an increase in
demand even though that will cause
the price to fall thus making all firms
collectively worse off.
Market Demand Versus
Individual Firm Demand Curve
Price
$10
Market
Market supply
Firm
Price
$10
8
8
6
6
4
Market
demand
2
0
1,000
3,000 Quantity
Individual firm
demand
4
2
0
10
20
30
Quantity
5