Perfect CompetitionEconomic Theory of Free Markets
PerfectCompetition
MonopolisticCompetition Oligopoly Monopoly
economic theory/model =>Unlimited # of competitors
Most competitive & Lowest Price
Least competitive & Highest Price
4 Market Structures
1 company => PGE, local water company
3-10 large companiesCar companies, airlines,Wireless service, smart phones
Many CompaniesRestaurants, hair salons,Bicycle shops, car repair
Market Characteristics• 4 market characteristics:
– # of Firms
– Type of Product
– Ease of entering or exiting industry
– Amount of Information
Determine pricing control of eachmarket structure
Perfect Competition
• Perfect Competition is an economic theory/model – “built” by economists to simulate a “perfect” self regulating economy
• It does not exist in the “real” world– The market for wheat & corn is close
• It produces the lowest price & highest quantity of all market
structures
Perfect Competition Market Characteristics
• Many/Unlimited small Firms
• Homogenous products (exactly the same!)
• Complete freedom to enter or exit industry– No costs to move, occurs immediately
• Perfect information
• Price Taker: – No price control—sell at Market Price
Perfect Competition Equilibrium
Price
Qty
T-Shirts
D1
S1
---------------------------
$10
Q1
E1
Price
Qty
A small firm can sell all of their production at the market price (price taker)
$10
Entire Industry 1-Individual Firm
D1
T-Shirts
“Zero” Economic Profit
• Competitive markets can earn profit or loss in the short run
• In long run profits are pushed to zero economic profit– It means you earn a “normal/fair” economic profit
• i.e. includes the Opportunity Cost of working
• You still earn a “fair living” based on your human capital
Perfect Competition in “Action”• The market is naturally “self-regulating”
• New firms will enter the market as if economic profit > zero– Due to easy & cheap entry/exit
• Firms exit the market whenever profits are less than zero
• Firms move between industries in search of higher profit
• In long run, inefficient producers are forced to leave & economic profit falls to zero (normal or fair profit level)
Worksheet
T-SHIRTSProfit = 100 day
BICYCLESProfit = 200 day
FOODProfit = 100 day
The Self-Regulation of Perfect Competition
S1
D1
S1
D1
S1
D1
------- P1 P1------- ---------------
Q1
E1
Q1--------
Q1
E1
--------
Q1
E1P1
S2 S2Firms exitmarket
Firms exitmarket
S2
Firms entermarket
Firms: exit markets with low profits enter markets with high profits
In long run, all firms will earn zero economic profit•In this example, assume $150 per day accounting profit
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