Lecture 9
Lecture 9
Lecture 9
• Aims
• Explain key features of a perfectly competitive market
• Price and output decisions in the short run and long run
in a perfectly competitive market
• Reading
• Gillespie, Chapters 11 and 12
Page 2
Perfect competition
Page 3
Introduction
4
Conditions of perfect competition
6
Conditions of perfect competition
2. Homogeneous products
• The good is exactly the same regardless of who
produces it
• Consumers cannot tell which firm produced a specific
item
– Example: a bag of popcorn
7
Conditions of perfect competition
8
Conditions of perfect competition
4. Perfect information
• Agents are constantly informed of the changing
market conditions
• Agents also know all the characteristics of the
goods
• Buyers know what all firms are charging
• Firms know what profits are being made in the
industry
9
Conditions of perfect competition
10
Conditions of perfect competition
11
Conditions of perfect competition
12
Firm and industry in perfect competition
Page 14
SR and LR in perfect competition
15
SR and LR in perfect competition
TR TC
0
q q q
or mR = mC
• Profits are maximum when the revenue of selling an
extra unit just covers the extra cost of producing that unit
Why?
16
SR and LR in perfect competition
Firm-market equilibrium
Firm level Market level
Price Price
mC
Zero profits
in equilibrium AC S
d=mR
p
D
q Quantity Q Quantity
17
SR and LR in perfect competition
Firm-market equilibrium
Firm level Market level
Price Price
mC Imagine a positive demand shock
Positive (e.g.: increase in income)
profits in SR
p q TC AC S
d2=mR2
p2
d=mR
p
D2
Total Cost D
q q2 Quantity Q Q2 Quantity
18
SR and LR in perfect competition
Firm-market equilibrium
Firm level Market level
Price Price
mC Positive profits attract firms
Return to to the market (free entry +
zero profits perfect information)
in LR AC S
S2
d2=mR2
p2
d=mR
p
D2
q q2 Quantity Q2 Q3 Quantity
19
SR and LR in perfect competition
21
Short run and long run equilibrium
23
Economic surplus
Surplus under perfect competition
P
Consumer surplus
All those
consumers willing (area below the demand and above P*)
to buy above P*
S
P*
All those
producers willing D
to supply below
P*
Producer surplus
(area above the supply and below P*)
Q* Q
24
Economic surplus
25
Economic surplus
• In the long run, due to the entry and exit of firms, only
normal profits are made