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\( \newcommand{\vecs}[1]{\overset { \scriptstyle \rightharpoonup} {\mathbf{#1}} } \) \( \newcommand{\vecd}[1]{\overset{-\!-\!\rightharpoonup}{\vphantom{a}\smash {#1}}} \)\(\newcommand{\id}{\mathrm{id}}\) \( \newcommand{\Span}{\mathrm{span}}\) \( \newcommand{\kernel}{\mathrm{null}\,}\) \( \newcommand{\range}{\mathrm{range}\,}\) \( \newcommand{\RealPart}{\mathrm{Re}}\) \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\) \( \newcommand{\Argument}{\mathrm{Arg}}\) \( \newcommand{\norm}[1]{\| #1 \|}\) \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\) \( \newcommand{\Span}{\mathrm{span}}\) \(\newcommand{\id}{\mathrm{id}}\) \( \newcommand{\Span}{\mathrm{span}}\) \( \newcommand{\kernel}{\mathrm{null}\,}\) \( \newcommand{\range}{\mathrm{range}\,}\) \( \newcommand{\RealPart}{\mathrm{Re}}\) \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\) \( \newcommand{\Argument}{\mathrm{Arg}}\) \( \newcommand{\norm}[1]{\| #1 \|}\) \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\) \( \newcommand{\Span}{\mathrm{span}}\)\(\newcommand{\AA}{\unicode[.8,0]{x212B}}\) Definition of Perfect CompetitionPerfect competition is a market structure that leads to the Pareto-efficient allocation of economic resources. Learning Objectives
Market structure is determined by the number and size distribution of firms in a market, entry conditions, and the extent of product differentiation. The major types of market structure include the following:
Perfect competition leads to the Pareto-efficient allocation of economic resources. Because of this it serves as a natural benchmark against which to contrast other market structures. However, in practice, very few industries can be described as perfectly competitive. Nevertheless, it is used because it provides important insights. A perfectly competitive market has several important characteristics:
Conditions of Perfect CompetitionA firm in a perfectly competitive market may generate a profit in the short-run, but in the long-run it will have economic profits of zero. Learning Objectives
The concept of perfect competition applies when there are many producers and consumers in the market and no single company can influence the pricing. A perfectly competitive market has the following characteristics:
All goods in a perfectly competitive market are considered perfect substitutes, and the demand curve is perfectly elastic for each of the small, individual firms that participate in the market. These firms are price takers–if one firm tries to raise its price, there would be no demand for that firm’s product. Consumers would buy from another firm at a lower price instead. Firm RevenuesA firm in a competitive market wants to maximize profits just like any other firm. The profit is the difference between a firm’s total revenue and its total cost. For a firm operating in a perfectly competitive market, the revenue is calculated as follows:
The average revenue (AR) is the amount of revenue a firm receives for each unit of output. The marginal revenue (MR) is the change in total revenue from an additional unit of output sold. For all firms in a competitive market, both AR and MR will be equal to the price. Profit MaximizationIn order to maximize profits in a perfectly competitive market, firms set marginal revenue equal to marginal cost (MR=MC). MR is the slope of the revenue curve, which is also equal to the demand curve (D) and price (P). In the short-term, it is possible for economic profits to be positive, zero, or negative. When price is greater than average total cost, the firm is making a profit. When price is less than average total cost, the firm is making a loss in the market. Perfect Competition in the Short Run: In the short run, it is possible for an individual firm to make an economic profit. This scenario is shown in this diagram, as the price or average revenue, denoted by P, is above the average cost denoted by C. Over the long-run, if firms in a perfectly competitive market are earning positive economic profits, more firms will enter the market, which will shift the supply curve to the right. As the supply curve shifts to the right, the equilibrium price will go down. As the price goes down, economic profits will decrease until they become zero. When price is less than average total cost, firms are making a loss. Over the long-run, if firms in a perfectly competitive market are earning negative economic profits, more firms will leave the market, which will shift the supply curve left. As the supply curve shifts left, the price will go up. As the price goes up, economic profits will increase until they become zero. In sum, in the long-run, companies that are engaged in a perfectly competitive market earn zero economic profits. The long-run equilibrium point for a perfectly competitive market occurs where the demand curve (price) intersects the marginal cost (MC) curve and the minimum point of the average cost (AC) curve. Perfect Competition in the Long Run: In the long-run, economic profit cannot be sustained. The arrival of new firms in the market causes the demand curve of each individual firm to shift downward, bringing down the price, the average revenue and marginal revenue curve. In the long-run, the firm will make zero economic profit. Its horizontal demand curve will touch its average total cost curve at its lowest point. The Demand Curve in Perfect CompetitionA perfectly competitive firm faces a demand curve is a horizontal line equal to the equilibrium price of the entire market. Learning Objectives
In a perfectly competitive market the market demand curve is a downward sloping line, reflecting the fact that as the price of an ordinary good increases, the quantity demanded of that good decreases. Price is determined by the intersection of market demand and market supply; individual firms do not have any influence on the market price in perfect competition. Once the market price has been determined by market supply and demand forces, individual firms become price takers. Individual firms are forced to charge the equilibrium price of the market or consumers will purchase the product from the numerous other firms in the market charging a lower price (keep in mind the key conditions of perfect competition). The demand curve for an individual firm is thus equal to the equilibrium price of the market. Demand Curve for a Firm in a Perfectly Competitive Market: The demand curve for an individual firm is equal to the equilibrium price of the market. The market demand curve is downward-sloping. The demand curve for a firm in a perfectly competitive market varies significantly from that of the entire market.The market demand curve slopes downward, while the perfectly competitive firm’s demand curve is a horizontal line equal to the equilibrium price of the entire market. The horizontal demand curve indicates that the elasticity of demand for the good is perfectly elastic. This means that if any individual firm charged a price slightly above market price, it would not sell any products. A strategy often used to increase market share is to offer a firm’s product at a lower price than the competitors. In a perfectly competitive market, firms cannot decrease their product price without making a negative profit. Instead, assuming that the firm is a profit-maximizer, it will sell its goods at the market price. Key Points
Key Terms
LICENSES AND ATTRIBUTIONS CC LICENSED CONTENT, SPECIFIC ATTRIBUTION
How does the demand curve faced by a perfectly competitive firm differ from the market demand curve in a perfectly competitive market explain?The market demand curve slopes downward, while the perfectly competitive firm's demand curve is a horizontal line equal to the equilibrium price of the entire market. The horizontal demand curve indicates that the elasticity of demand for the good is perfectly elastic.
How is the demand curve perceived by a perfectly competitive firm different from the demand curve perceived by a monopolist?The demand curve as perceived by a perfectly competitive firm is not the overall market demand curve for that product. However, the firm's demand curve as perceived by a monopoly is the same as the market demand curve.
How is the demand curve for a monopolistically competitive firm different from the demand curve of a perfectly competitive firm?Market Power. The demand curve for an individual firm is downward sloping in monopolistic competition, in contrast to perfect competition where the firm's individual demand curve is perfectly elastic.
How is the demand curve perceived by a perfectly competitive firm different from the demand curve perceived by a monopolist quizlet?The demand curve perceived by a perfectly competitive firm is flat, while the demand curve perceived by a monopolist is downward sloping. You just studied 9 terms!
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