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The Theory of Perfect Competition*
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Assumes:
1) There are many sellers and many buyers
2) Homogeneous product.
3) Buyers and sellers have all relevant information
4) Entry into or exit from the industry is easy
Predicts:
1) Zero economic profit exists in the long run
2) In equilibrium, price equals marginal cost
3) In the short run, firms will stay in business as long as price covers average variable costs
4) In the long run, firms will stay in business as long as price covers average total costs
5) In the short run, an increase in demand will lead to a rise in price; price in the long run depends on whether the firm is in an increasing-, decreasing-, or constant-cost industry.
1) There are many sellers and many buyers
2) Homogeneous product.
3) Buyers and sellers have all relevant information
4) Entry into or exit from the industry is easy
Predicts:
1) Zero economic profit exists in the long run
2) In equilibrium, price equals marginal cost
3) In the short run, firms will stay in business as long as price covers average variable costs
4) In the long run, firms will stay in business as long as price covers average total costs
5) In the short run, an increase in demand will lead to a rise in price; price in the long run depends on whether the firm is in an increasing-, decreasing-, or constant-cost industry.
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The Perfectly Competitive Firm*
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- price taker. It sells its product only at the market-established equilibrium price.
-horizontal, perfectly elastic) demand curve.
-demand curve and its marginal revenue curve are the same.
-maximizes profits by producing at MR = MC.
-price equals marginal revenue
-resource allocative efficient because it produces at P = MC.
-horizontal, perfectly elastic) demand curve.
-demand curve and its marginal revenue curve are the same.
-maximizes profits by producing at MR = MC.
-price equals marginal revenue
-resource allocative efficient because it produces at P = MC.
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Production in the Short Run*
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- P > ATC (> AVC), economic profits, continue to operate in the short run
- P < AVC (< ATC), takes losses, shuts down else it would increase the losses
- ATC > P > AVC, takes losses. continues operating in the short run else it would increase the losses
- produces in the short run only when price is greater than the average variable cost
- the portion of its marginal cost curve that lies above the average variable cost curve is the firm's short-run supply curve.
- P < AVC (< ATC), takes losses, shuts down else it would increase the losses
- ATC > P > AVC, takes losses. continues operating in the short run else it would increase the losses
- produces in the short run only when price is greater than the average variable cost
- the portion of its marginal cost curve that lies above the average variable cost curve is the firm's short-run supply curve.
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Conditions of Long-Run Competitive Equilibrium*
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No incentive for firms:
1) to enter or exit the industry
2) to produce more or less output
3) to change plant size
Conditions:
1) Economic profits are zero
2) Firms are producing the quantity of output at which price is equal to marginal cost. (when P = MC, then MR = MC and firm is maximizing profits.)
3) SRATC = LRATC at the quantity of output at which P = MC.
- A perfectly competitive firm exhibits productive efficiency because it produces its output in the long run at the lowest possible per-unit cost.
1) to enter or exit the industry
2) to produce more or less output
3) to change plant size
Conditions:
1) Economic profits are zero
2) Firms are producing the quantity of output at which price is equal to marginal cost. (when P = MC, then MR = MC and firm is maximizing profits.)
3) SRATC = LRATC at the quantity of output at which P = MC.
- A perfectly competitive firm exhibits productive efficiency because it produces its output in the long run at the lowest possible per-unit cost.
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Industry Adjustment to a Change in Demand*
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Constant-Cost Ind - increase in demand results in same equilibrium price (perfectly elastic in LR)
Increasing-Cost Ind - increase in demand results in higher equilibrium price (upward sloping in LR)
Decreasing-Cost Ind - increase in demand results in lower equilibrium price (downward sloping in LR)
Increasing-Cost Ind - increase in demand results in higher equilibrium price (upward sloping in LR)
Decreasing-Cost Ind - increase in demand results in lower equilibrium price (downward sloping in LR)
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Constant Cost Industry
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An industry in which average total costs do not change as (industry) output increases or decreases when firms enter or exit the industry, respectively.
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Decreasing Cost Industry
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An industry in which average total costs decrease as output increases and increase as output decreases when firms enter and exit the industry, respectively.
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Increasing Cost Industry
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An industry in which average total costs increase as output increases and decrease as output decreases when firms enter and exit the industry, respectively.
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Long-run (industry) supply (LRS) curve
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Graphic representation of the quantities of output that the industry is prepared to supply at different prices after the entry and exit of firms are completed.
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Long-run competitive equilibrium
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The condition where P = MC = SRATC = LRATC. There are zero economic profits, firms are producing the quantity of output at which price is equal to marginal cost, and no firm has an incentive to change its plant size.
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Marginal Revenue (MR)
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The change in total revenue that results from selling one additional unit of output.
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Market Structure
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The particular environment of a firm, the characteristics of which influence the firm's pricing and output decisions.
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Perfect Competition
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A theory of market structure based on four assumptions: (1) There are many sellers and buyers, (2) sellers sell a homogeneous good, (3) buyers and sellers have all relevant information, and (4) entry into or exit from the market is easy.
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Price Taker
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A seller that does not have the ability to control the price of the product it sells; the seller takes the price determined in the market.
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Productive Efficiency
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The situation that exists when a firm produces its output at the lowest possible per-unit cost (lowest ATC).
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Profit-Maximization Rule
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The rule that profit is maximized by producing the quantity of output at which MR = MC.
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Resource Allocative Efficiency
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The situation when firms produce the quantity of output at which price equals marginal cost: P = MC.
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Short-Run (firm) Supply Curve
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The portion of the firm's marginal cost curve that lies above the average variable cost curve.
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Short-Run Market (industry) Supply Curve
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The horizontal addition of all existing firms' short-run supply curves.
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