Perfect Competition
Objectives
By the end of this lesson you should be able to…

Define Perfect Competition

Explain 2 characteristics of the Perfect Competition model

Explain why, in the Perfect Competition model, P=AR=D for a
firm

Explain the long run equilibrium diagram
Starter

Mr M’s Perfectly Competitive Carrots!

In your notes quickly draw a spider diagram of the key characteristics of
market structure
Market Structure
Number of firms
Perfect
Knowledge –
every firm has
access to the
same info
Degree
EoS
of power
Sunk costs
of
each
Limit pricing
Legal
firm
Anti-comp practices
Market
concentration
Market Structure
characteristics
Knowledge/ Information
New firms (entrants) attracted by
abnormal profits
Barriers to entry /
exit
Products
differentiated from
competition –
easier to control
Product homogeneity /
branding
Profit levels
Market Structure
Perfect
Competition
Pure
Monopoly
More competitive (fewer imperfections)
Market Structure
Perfect
Competition
Pure
Monopoly
Less competitive (greater degree
of imperfection)
Market Structure
Pure
Monopoly
Perfect
Competition
Monopolistic Competition
Oligopoly
Duopoly Monopoly
The further right on the scale, the greater the degree
of monopoly power exercised by the firm.
So Perfect Competition

Is a model of an extreme market
structure

Which is based on certain assumptions
Basic Assumptions

Many small sellers each of whom produces an insignificant
percentage of total market output and thus exercise no control
over the market price

Many individual buyers – no control over the market price

No barriers to entry/ exit

Homogenous product – perfect substitutes. This leads to firm
being passive ‘price takers’ and facing a perfectly elastic
demand curve for their product.

No externalities arising from production and/or consumption
which lie outside the market
Many small firms
 each
of whom
The
firm’s demand
curveproduces
is perfectly an
elastic
because any firm that raises
its prices seesof
demand
percentage
total fall
to zeromarket
as consumers,
with and
perfect
knowledge
, switch
output
thus
exercise
no
to other
producers
offering
identicalprice
product for a
control
over
the an
market
better price
insignificant
P
S
P
Price takers…so small and so
many – individual firms cannot
influence price
P = D = AR
D
O
Industry
Q
O
Firm
Q
Homogenous goods/services

Products perceived to be identical

Perfect substitutes

Consumers buy from cheapest provider

Each firm is a passive price taker

Firms face perfectly e l a s t i c demand
curve for its product
Perfect Information

Consumers have readily
available info about the
market – prices and
products from competing
suppliers

Can access info at zero
cost

Few transaction costs
involved in searching for
price info
Freedom of entry and exit

No barriers to entry /exit

No sunk costs

Entry and exit from the market
feasible in the long run

If firms are making abnormal
profits, new firms can easily
enter the market

This assumption ensures all
firm make normal profits in the
long run
Your go…

Taking the characteristics of perfect competition insert ticks to
express the degree to which each of the markets displays
them…
Real examples of Perfect
Competition – FX Market

Currency markets – taking us closer to
perfect competition

Global FX markets are where all buying
and selling of world currencies takes
place.
$4,000,000,000,000
vs.
$37,000,000,000

24x5 trading

$4 trillion daily trade value vs New York
Stock Exchange: $37bln
Why does a currency market
come close to perfect competition?

Homogenous product – a dollar is a dollar, a
pound a pound, wherever you trade it

Many buyers and sellers – all are price takers

High quality real-time info and low transaction
costs

Thomson Reuters datafeed service delivers
price data from the exchange to your office in
under
a millisecond….1/1000
a second!
trading
allows
buyers andth ofsellers
to
Electronic
only with those who offer the best prices
deal
Other examples

Commodity markets

Softs - grown


Wheat, coffee, sugar, cocoa, rice
Hards – extracted through mining



Metals
Gold
Oil
You will need to reproduce
diagrams

In an essay or Data Response

Need to consider both the individual firm and the
market (industry)

Investigate firm’s output, price, revenue and profit in
both the short and the long run

Start with the long run…
Long run equilibrium
•Before we look at the market dynamics, lets first understand what the end state looks like…
MR=MC
Maximum profits
MC
AC
P
S
P
P = D = AR = MR
P1
D
O
Q
Industry
O
Q1
Firm
Q
To recap

What are the characteristics of Perfect Competition?

Do firms in perfectly competitive markets make a
loss?

What would the concentration ratio be for a perfectly
competitive industry?

Why is Perfect Competition rare in reality?
Homework...by tomorrow!

Learn the characteristics of Perfect
Competition

Read article: ‘Perfect Competition’ – Does it
exist, and does it matter?
Plenary
By the end of this lesson you should be able to…

Define Perfect Competition

Explain 2 characteristics of the Perfect Competition model

Explain why, in the Perfect Competition model, P=AR=D for a
firm

Explain the long run equilibrium diagram