Econ 201
Chpt 14:
Perfect Competition
1
Overview of Market Structures
Quick Reference to Basic Market Structures
Market Structure
Seller Entry Barriers
Seller Number
Buyer Entry Barriers
Buyer Number
Perfect Competition
No
Many
No
Many
Monopolistic competition
No
Many
No
Many
Oligopoly
Yes
Few
No
Many
Oligopsony
No
Many
Yes
Few
Monopoly
Yes
One
No
Many
Monopsony
No
Many
Yes
One
2
Overview
• market structure describes the state of a market with respect to
competition.
• The major market forms are:
– Perfect competition, in which the market consists of a very large number
of firms producing a homogeneous product.
– Monopolistic competition, also called competitive market, where there
are a large number of independent firms which have a very small
proportion of the market share.
– Oligopoly, in which a market is dominated by a small number of firms
which own more than 40% of the market share.
– Oligopsony, a market dominated by many sellers and a few buyers.
– Monopoly, where there is only one provider of a product or service.
– Natural monopoly, a monopoly in which economies of scale cause
efficiency to increase continuously with the size of the firm.
– Monopsony, when there is only one buyer in a market.
3
Basic Assumptions
•
Atomicity
–
There is a large number of small producers and consumers on a given market,
•
–
•
Any firm may enter or exit the market as it wishes (no barriers to entry).
Individual buyers and sellers act independently
–
•
All firms have access to production technologies, and resources are perfectly mobile.
Free entry
–
•
All firms and consumers know the prices set by all firms
Equal access
–
•
Goods and services are perfect substitutes; that is, there is no product differentiation. (All
firms sell an identical product)
Perfect and complete information
–
•
Firms are price takers, meaning that the market sets the price that they must choose.
Homogeneity
–
•
each so small that its actions have no significant impact on others.
The market is such that there is no scope for groups of buyers and/or sellers to come
together to change the market price (collusion and cartels are not possible under this market
structure)
Behavioral assumptions of perfect competition are that:
–
–
Consumers aim to maximize utility
Producers aim to maximize profits.
4
Firm’s Output/Supply Decision
• In the short-run
– MC curve >= min(AVC)
5
The Shut-down Point (price)
6
Short-run Profitability
• In the short-run, it’s possible for a firm (or
firm’s) to earn above a normal rate of
return (or an economic profit)
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Long-run Profitability
• Positive economic profit cannot
be sustained
– Entry of new firms causes:
• Market supply curve to shift to
the right
• Lowering the market
equilibrium price and
• Lowering each firm’s demand
curve (or constant price)
– In the long run, the firm will make
only normal profit (zero economic
profit). Its horizontal demand curve
will touch its average total cost
curve at its lowest point
8
In the long-run, entry will dissipate
short-run economic profits
9
How Can There Be
Short-run Profitability?
• In the short-run, different firms may have
different scale/technology
– Operate in different parts of the LRAC
– In the long-run - all will adopt least cost
10
Top Pot Donuts
• On April 8, Top Pot is slated to be in all company-owned
Starbucks Corp. stores in 50 states, the companies said
Thursday.
• "This is a big, big leap for us and something we are
really proud of," said Mark Klebeck, one of Top Pot's
three co-founders.
• Klebeck said Top Pot currently is in about 5,000
Starbucks locations in 25 states.
• Starbucks, at the end of last year, had 7,087 companyowned stores in the U.S., but it was not disclosed how
many stores would be operating in April as the company
is slowing down its growth. Starbucks had an additional
4,081 licensed stores and has more than 15,000 stores
worldwide.
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Strategy and Policy
• Firms would prefer to avoid perfect competition.
– Firms become victims of their own efficiency.
– In the short-run, if one firm adopts a cost-savings
technology -> short-run economic profits
– In the long-run -> others will imitate and reduce their
costs
• Price-taker -> can’t affect market price
– No control over it’s (firm’s) demand
12
What Do Economist Like
About Perfect Competition?
• Perfectly Competitive Markets
– Allocative efficient and productive efficient
13
Pareto Efficiency
• Allocative Efficiency:
– When price is equal to its marginal costs
• Consumers’ (marginal) value of last (marginal) unit equals
the resource’s marginal cost
• Opportunity costs (value) of alternative use of resource is
given by marginal cost
• Productive Efficiency
– Goods are produced at minimum cost
• In the long-run: competitive firms produce at minimum of
LRAC
– Economic welfare is maximized
• Sum of consumer and producer surplus
• Technological Innovation
14
The Long-Run Supply Curve
• Consider an increase in demand:
– The increase in demand leads to an increase
in price.
– The higher price causes firms to earn an
economic profit.
– Economic profits cause new firms to enter the
market.
– As new firms enter, the price falls.
15
Long-Run Supply Curves
• Types
– Constant cost -> no change in price
– Decreasing cost -> price will fall
– Increasing cost -> price will increase
16
Dynamics
• What does the supply expansion path tell
us about industry costs?
17
The Long-Run Supply Curve in an
Constant-Cost Industry
• An constant-cost industry is an industry in
which production costs remain unchanged as
the industry expands.
– As a result, price is driven back down to the initial
level by the entry of new firms.
18
The Long-Run Supply Curve in a
Constant-Cost Industry
19
The Long-Run Supply Curve in an
Increasing-Cost Industry
• An increasing-cost industry is an industry in
which production costs increase as the industry
expands.
– As a result, price cannot be driven back down to the
initial level by the entry of new firms.
20
The Long-Run Supply Curve in an
Decreasing-Cost Industry
• A decreasing-cost industry is an industry in
which production costs decrease as the industry
expands.
– As a result, price will be driven below the initial level
by the entry of new firms.
21
The Long-Run Supply Curve in
Increasing- and Decreasing-Cost
Industries
22
Dynamics
• Expansion path tells us in which portion of
the cost curve the industry operates in
23
Summary
• Perfect competition is the least concentrated of
the four market structures.
• The model of perfect competition assumes a
large number of buyers and sellers, an identical
product, perfect information, and freedom of
entry and exit.
• Perfectly competitive firms are price takers.
24
Summary (cont’d)
• Perfectly competitive firms maximize profit
by producing the level of output for which
marginal revenue equals marginal cost.
• A perfectly competitive firm’s supply curve
is the portion of the short-run MC curve
above AVC.
– The market supply curve is found by summing the
individual firms’ supply curves.
25
Summary (cont’d)
• In the long run, perfectly competitive firms earn
zero economic profits.
• The long-run supply curve shows the
quantity that all firms are willing to supply at
different prices.
26