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