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Perfect Competition

What is it? Firm behavior Short run Long run

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Perfect Competition

many firms, many buyers identical product easy entry/exit for the market prices known existing firms have no advantage

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examples

wheat farming dry cleaning paper cups

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Firm Behavior

maximize profits TR > TC

economic profits

TR = TC normal profits

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Firm is price taker

cannot influence price take price as given, choose Q

firm demand is perfectly elastic horizontal line

MR = P firm sells all it wants at price, P

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Profit maximizing

firm chooses Q to max profits where TR - TC is largest

-- where MR = MC why MR = MC?

MR > MC

-- output adding to profit MR < MC

-- output taking away from profit

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Market for syrup (all firms)P

Q (cans/day)

D

S

$8

100

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Firm’s demand, cost curveP

Q (cans/day)

$8 D = MR = P

MC

10

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firm is price taker what if price too low to earn profit?

economic loss will firm exit?

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costs & exit

firm will stay, in SR, if P > AVC

why? if firm exits, loses TFC if P = AVC

-- loss from staying

= loss from exit

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SR equilibrium

two cases economic profit economic loss

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Case 1: economic profit

P = $8, Q = 10 ATC = $5 profit = ($8)(10) - ($5)(10) = $30

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P

Q (cans/day)

$8 D = MR = P

MC

10

ATC

$5

economicprofit

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case 2: economic loss

P = $3, Q = 7 ATC = $5 profit = ($3)(7) - ($5)(7) = - $14

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P

Q (cans/day)

$3 D = MR = P

MC

7

ATC

$5

economicloss

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12.3 LR Equilibrium

entry & exit of firms firms earn normal profit

economic profit will be zero

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why zero economic profit?

if economic profit > zero firms enter (S shifts right) price falls profit falls to zero

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P

Q (cans/day)

D

S

$8

100

S’

$5

120

market for syrup

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Syrup firmP

Q (cans/day)

D = MR = P

MC

ATC

$5

zeroeconomicprofit

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if economic profit < zero firms exit (S shifts left) price rises profit rises to zero

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P

Q (cans/day)

D

S

$5

120

market for syrup

$3

140

S’’

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P

Q (cans/day)

$3 D = MR = P

MC

7

ATC

$5

economicloss

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Syrup firmP

Q (cans/day)

D = MR = P

MC

ATC

$5

zeroeconomicprofit

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Shifts in market demand

change price in SR profits or losses

in LR affect exit/entry return to zero economic profit

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Summary

price takers MR = MC determines equilibrium Q

SR: economic profit or loss LR: economic profit is zero due

to entry/exit