Perfect Competition
Objectives
By the end of this lesson you should be able to…
Define Perfect Competition
Explain 2 characteristics of the Perfect Competition model
Explain why, in the Perfect Competition model, P=AR=D for a firm
Explain the long run equilibrium diagram
Starter
Mr M’s Perfectly Competitive Carrots!
In your notes quickly draw a spider diagram of the key characteristics of market structure
Market Structure
Market Structure characteristics
Knowledge/ Information Product homogeneity / branding
Number of firms
Perfect Knowledge – every firm has access to the
same info
Barriers to entry / exit
Products differentiated from
competition – easier to control
Degree of power of each firm
Profit levelsNew firms (entrants) attracted by abnormal profits
Market concentration
EoSSunk costs
LegalLimit pricing
Anti-comp practices
Market Structure
More competitive (fewer imperfections)
Perfect Competition
Pure Monopoly
Market Structure
Less competitive (greater degree of imperfection)
Perfect Competition
Pure Monopoly
Market StructurePerfect
Competition
Pure Monopoly
Monopolistic Competition Oligopoly Duopoly Monopoly
The further right on the scale, the greater the degree of monopoly power exercised by the firm.
So Perfect Competition
Is a model of an extreme market structure
Which is based on certain assumptions
Basic Assumptions Many small sellers each of whom produces an insignificant
percentage of total market output and thus exercise no control over the market price
Many individual buyers – no control over the market price
No barriers to entry/ exit
Homogenous product – perfect substitutes. This leads to firm being passive ‘price takers’ and facing a perfectly elastic demand curve for their product.
No externalities arising from production and/or consumption which lie outside the market
Many small firms each of whom produces an
insignificant percentage of total market output and thus exercise no control over the market price
P
QO
D
S P
QO
P = D = AR
Price takers…so small and so many – individual firms cannot
influence price
The firm’s demand curve is perfectly e l a s t i c because any firm that raises its prices sees demand fall to zero as consumers, with perfect knowledge,
switch to other producers offering an identical product for a better price
Industry Firm
Homogenous goods/services Products perceived to be identical
Perfect substitutes
Consumers buy from cheapest provider
Each firm is a passive price taker
Firms face perfectly e l a s t i c demand curve for its product
Perfect Information Consumers have readily
available info about the market – prices and products from competing suppliers
Can access info at zero cost
Few transaction costs involved in searching for price info
No barriers to entry /exit
No sunk costs
Entry and exit from the market feasible in the long run
If firms are making abnormal profits, new firms can easily enter the market
This assumption ensures all firm make normal profits in the long run
Freedom of entry and exit
Your go…
Taking the characteristics of perfect competition insert ticks to express the degree to which each of the markets displays them…
Real examples of Perfect Competition – FX Market
Currency markets – taking us closer to perfect competition
Global FX markets are where all buying and selling of world currencies takes place.
24x5 trading
$4 trillion daily trade value vs New York Stock Exchange: $37bln
$4,000,000,000,000vs.
$37,000,000,000
Why does a currency market come close to perfect competition?
Homogenous product – a dollar is a dollar, a pound a pound, wherever you trade it
Many buyers and sellers – all are price takers
High quality real-time info and low transaction costs
Electronic trading allows buyers and sellers to deal only with those who offer the best prices
Thomson Reuters datafeed service delivers price data from the exchange to
your office in under a millisecond….1/1000th of a second!
Other examples
Commodity markets Softs - grown
Wheat, coffee, sugar, cocoa, rice
Hards – extracted through mining Metals Gold Oil
You will need to reproduce diagrams
In an essay or Data Response
Need to consider both the individual firm and the market (industry)
Investigate firm’s output, price, revenue and profit in both the short and the long run
Start with the long run…
Long run equilibrium
P
QO
D
S P
QO
P = D = AR = MR
Industry Firm
P1
Q1
MCAC
MR=MCMaximum profits
•Before we look at the market dynamics, lets first understand what the end state looks like…
To recap
What are the characteristics of Perfect Competition?
Do firms in perfectly competitive markets make a loss?
What would the concentration ratio be for a perfectly competitive industry?
Why is Perfect Competition rare in reality?
Homework...by tomorrow!
Learn the characteristics of Perfect Competition
Read article: ‘Perfect Competition’ – Does it exist, and does it matter?
Plenary
By the end of this lesson you should be able to…
Define Perfect Competition
Explain 2 characteristics of the Perfect Competition model
Explain why, in the Perfect Competition model, P=AR=D for a firm
Explain the long run equilibrium diagram