Perfect Competition
Chpt 12
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.
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Overview of Market Structures
Quick Reference to Basic Market Structures
Market Structure
Seller Entry Barriers
# of Sellers
Buyer Entry Barriers
# Buyers
Perfect Competition
No
Many
No
Many
Monopolistic competition
No
Many
No
Many
Oligopoly (few firms)
Yes
Few
No
Many
Oligopsony (few buyers)
No
Many
Yes
Few
Monopoly (one firm)
Yes
One
No
Many
Monopsony (one buyer)
No
Many
Yes
One
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Basic Assumptions: Perfect Competition

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/well-being

Producers aim to maximize profits.
4
What is a Competitive Market?


Competitive market

Market with many buyers and sellers

Trading identical products

Each buyer and seller is a price taker

Firms can freely enter or exit the market
Implying

No firm or individual has any “market power”

No ability to set or effect market equilibrium price
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Profit Maximizing Rule

Quantity (Q)
 How

Price (P)
 Price

=PQ
Total Costs (TC)
 Sum

charged per driveway
Total Revenue (TR)
 TR

many driveways did Mr. Plow clear?
of all production costs at a certain level of output
Profit (π)

π = TR – TC
Profit Maximizing Rule


Marginal Revenue (MR)

MR = ΔTR ÷ ΔQ

Δ = change in

For a competitive firm, MR = P
Marginal Cost (MC)

MC = ΔTC ÷ ΔQ

Additional costs of producing additional units
Profit Maximizing Rule
 Change
 ΔProfit
 Profit
in Profit
= MR – MC
maximizing rule:
 To
maximize profits, the firm should use a
marginal analysis
 Profit
is maximized by choosing the level of
output such that
MR = MC
Profit Maximizing Rule

Profit is maximized by choosing the level of
output such that
MR = MC

If MR > MC
 The

firm can increase profits by producing more Q
If MR < MC
 The
firm has produced “too much” Q, and profits are
not maximized