Downloaded 1,064 times
Uploaded bySuresh Madhavan
Perfect competition
Perfect competition is a market structure with many small firms, homogeneous products, perfect information and free entry and exit. In the short run, firms maximize profits where marginal cost (MC) equals marginal revenue (MR). Abnormal profits attract new firms, lowering prices to normal profits when MC equals average cost (AC). Allocative efficiency occurs where MC equals average revenue (AR). In the long run, productive, allocative and profit maximizing efficiencies are achieved at the same output level.
In this document
Powered by AI
Introduction to various types of market structures, focusing on the concept of perfect competition.
Perfect competition is based on assumptions like many firms, price takers, homogeneous products, the freedom of entry/exit, and perfect market knowledge.
Industry and firm demand curves in perfect competition; firms are price takers maximizing profit under the conditions where MC=MR.
Short-run abnormal profits can attract new firms, leading to a supply shift that normalizes profits in the long run.
Short-run losses lead to firms exiting the market, shifting supply and prices up until normal profits are achieved.
In the long run, firms can only achieve normal profit as entry and exit balance out any short-run abnormal profits or losses.
Discussions on productive and allocative efficiency, highlighting conditions for Pareto optimality in resource allocation.
The relationships between profit maximization, productive, and allocative efficiencies in both short and long runs in perfect competition.
Real-life examples of perfect competition like financial and agricultural markets; advantages include resource efficiency and consumer benefits.
More Related Content
Perfect competition
- 2.
- 3. Perfect Competition • Itis a theoretical model.
- 4. • Assumptions: • Largenumber of firms.
- 5. • Assumptions: • Individualfirms are “price takers”.
- 6. • Assumptions: • Homogeneousproducts.
- 7. • Assumptions: • Freedomof entry and exit.
- 8. • Assumptions: • Perfectknowledge of the market.
- 9. Demand curves forindustry and firm in perfect competition • Industry: • Normal demand and supply curves. • More supply at higher price and less demand and higher price. • Firm: • Price takers. • Have to accept the industry price.
- 10. Profit maximization forthe firm in perfect competition • Profit maximization rule: MC=MR • For a firm, P=D=AR=MR
- 11. Short run abnormalprofit in perfect competition • Firms are more than covering their total cost, including opportunity cost.
- 12. Short-run abnormal profitto long-run normal profit Short-run abnormal profit attracts more firms to the industry.(Freedom of entry) Supply curve shifts to the right.(S to S1) This pulls down the price. (P to P1) Demand curve shifts downwards. (D to D1) At new price, P= C In the long-run there is no abnormal profit.
- 13. Short-run loss inperfect competition • Firms are not covering their total cost.
- 14. Short-run losses tolog-run normal profit • Due to losses, a few firms will leave the industry.(Freedom of exit) • Supply curve shifts to the left.(S to S1) • Industry price begin to rise.(P to P1) • Demand curve shifts upwards.(D to D1) • At new price, P=C (normal profit)
- 15. Long-run equilibrium • Inthe long-run, firms in perfect competition can make only normal profit. • Freedom of entry and exit eliminates the short-run abnormal profit and short- run losses. • In the long-run equilibrium, there is no incentive for firms to enter or leave the industry.
- 16. Productive and allocativeefficiency • Productive efficiency: • A firm is productive efficient when it produces at its lowest possible unit cost(average cost) • MC=AC • This means the combination of resources is efficient and there no wastage of resources.
- 17. Productive and allocativeefficiency • Allocative Efficiency: • This is socially optimum level of output. • Producers are producing the optimal mix of goods and services required by consumers. • Price reflects the value that consumers place on a good. • MC=AR Cost to The value to producers consumers
- 18. Pareto Optimality • Allocativeefficiency means there is Pareto optimality. • Situation where it is impossible to make one person better off without making someone else worse off. • An economic state where resources are allocated in the most efficient manner.
- 19. Profit maximization •MC=MR Productive efficiency •MC=AC Allocative efficiency •MC=AR
- 20. Productive and allocativeefficiency in the short run in perfect competition • Profit maximization level of output is at q(MC=MR) • Allocative efficiency is at q2 (MC=AR) • Productive efficiency is at q1 (MC=AC)
- 21. Productive and allocativeefficiency in the short run in perfect competition • Profit maximization level of output is at q(MC=MR) • Allocative efficiency is at q2 (MC=AR) • Productive efficiency is at q1 (MC=AC)
- 22. Productive and allocativeefficiency in the long run • In the long run, Profit maximization level of output=productive efficiency=allocative efficiency. • This is because, there is perfect knowledge and same cost curves.
- 23. Examples of perfectcompetition: – Financial markets – stock exchange, currency markets, bond markets? – Agriculture?
- 24. Advantages of Perfect Competition: High degree of competition helps allocate resources to most efficient use Price = marginal costs Normal profit made in the long run Firms operate at maximum efficiency Consumers benefit