1

perfect competition1. Many participants, buyers and sellers.

2. Sellers are infinitesimally small.

3. Homogeneous products.

4. Free entry and exit.

5. Perfect information.

2

1. Competitive Firms

1. a. In the short run almost horizontal demand.

2. b. supply curve of firm is the MC above AVC.

3. c. Industry supply horizontal sum of firms mcs

(the sum of their output at a price).

3

AC1MC

D = MRP*

q*

Short Run Profit Maximizing solution for a competitive firm; MC seems to be the supply curve.

ACq*

Profits

4

AVC

ACsupply curve of firm is the mc above avc

AFC

P

Qq1 q2 q3

p3

p2

p1

S

MC

5

supply curve of industry is the horizontal sum of each individual firm’s supply.

Firm A Firm B Firm CIndustry

qaqb

qc Qa+b+c

p1

s

ss

S

qa1 Q=qa1

p2

6

Competitive Equilibrium

1. a. fixed number of firms in SR!! no entry or exit allowed; therefore, industry supply can not change

2. b. for firm: d=mr=p=mc

3. c. In longer run, profits draw entry of firms, increasing industry supply, lowering price and profits down to zero; negative profits cause exit, decreasing supply, raising price and bring profit back to zero.

7

ACP

"Representative" Firm in Industry

P

Competitive Industry

This represents a competitive industry in a short run equilibrium.Meaning that until entry or exit can occur, nothing will change sincethe price equalizes quantity demanded and supplied. But the typical

firm earns profits (right hand picture) and entry will increase industry supply in long run, lowering price.

p1

qQ1

8

ACP

"Representative" Firm in Industry

P

Competitive Industry

This represents a competitive industry in a long run equilibrium (price P3). Once achieved, nothing will change since the price equalizes quantity demanded and supplied. Since the typical firm earns no

profits (right hand picture) no further entry or exit will occur.

S1

S3

p1p2

S2

p3

Q1 Q2 Q3 q q1

9

Efficiency of Competition1. a. no deadweight losses-- i.e. on prod poss frontier

2. b. each firm at bottom of ac--- seems good, but actually

irrelevant for economic efficiency

3. c. consumers vote with dollars. Popular products make

money, drawing entry until enough of the product is

produced. The drive for profits makes firms efficient

and efficient firms drive out inefficient firms (Darwin

and Economics).

10

ACP

"Representative" Firm in Industry

P

Competitive Industry

The right hand diagram represents the typical firm in long run equilibrium.The firm is at the bottom of the AC, meaning that costs are minimized.

Industry has zero deadweight loss.

q

1

2

CS=1 PS=2

11

Efficiency of Competition (rpt)1. a. no deadweight losses-- i.e. on prod poss frontier

2. b. each firm at bottom of ac--- seems good, but actually

irrelevant for economic efficiency

3. c. consumers vote with dollars. Popular products make

money, drawing entry until enough of the product is

produced. The drive for profits makes firms efficient

and efficient firms drive out inefficient firms (Darwin

and Economics).

12

Competitive Markets that aren’t1. Example of taxi-cab medallions

2. Television station licenses.

3. Medical doctors

4. Many, many, more.

13

Long Run Supply: No External Effects

1. Competitive industry must have constant costs in this case.

2. Long run industry supply must be horizontal at the bottom of the AC of representative firm.

3. Long run industry output changes only through entry and exit of new firms.

14

ACP

"Representative" Firm in Industry

P

Competitive Industry

The typical firm in long run equilibrium at the bottom of its AC, meaning that costs are minimized. With no external effects, each firm always produces ‘q’ and long run industry output only changes when

the number of firms changes.

q

LRS

SRS

P1

15

Long Run Supply with External Effects

1. Competitive industry may have increasing or decreasing costs in this case.

2. Long run industry supply changes only as the bottom of the AC of representative firm changes.

16

P

Q

AC for representative firm as industry output Q increases.

AC (Q1)

AC (Q2)

AC (Q3)

17

P

Q

Q1Q2 Q3

Long run supply in decreasing cost competitive industry

AC (Q1)

AC (Q2)

AC (Q3)

LRS