PERFECT COMPETITION
This presentation considers
the characteristics of a
perfectly competitive
market
Perfect Competition
Assumptions Behind a Perfectly Competitive Market
Many small firms each with a very small share of market
Each firm is too small to influence price via a change in
market supply – each individual firm is assumed to be a price
taker.
Identical output produced by each firm – homogeneous
products that are perfect substitutes for each other
Perfect knowledge among producers & consumers
No barriers to entry & exit of firms in long run – market is
open to competition from new suppliers – this affects the long
run profits made by each firm in the industry
Perfect Competition
Price Taking Firms
Competitive firms have no direct influence on the ruling
market price
In contrast, a business with monopoly (or market) power can
make their own pricing decisions
Examples of price-taking behaviour:
 Local farmers selling their produce at the market. (my father in
law is a coffee farmer- totally dependent on the “market
price”).
 You selling your local currency to buy foreign currency
 Share prices- you have to sell your shares at the market price.
Perfect Competition
Importance of the Perfect Competition Model
It is often argued that few markets exactly meet the
characteristics of Perfect Competition and therefore the model
is of little use. However this is wrong in that….
Some markets do meet the criteria
The model is an extreme but gives us answers to what happens
when a market becomes more competitive.
The standard “neo-classical” view is that competition drives an
improvement in economic welfare and efficiency
Competition 'sorts' firms – it forces under-performing firms out of
the market and shifts market share to more efficient firms in the
long run
Competition encourages firms to innovate and adopt bestpractise techniques.
Perfect Competition
The Competitive Firm’s Demand Curve
Price
Industry
Price
Individual firm
Ms
AR=MR
P1
Each firm is a price taker in a
perfectly competitive market
Md
Industry Output
Perfect Competition
Firm’s Output
A Shift in Market Demand
Price
Industry
Price
Individual firm
Ms
AR2=MR2
P2
P1
AR=MR
D2
Md
Industry Output
Perfect Competition
A rise in demand increases the
price that each firm can take in
the market
Firm’s Output
Shifts in Market Supply
Price
Industry
Price
Individual firm
Ms
S2
AR=MR
P1
P2
AR2=MR2
Md
Industry Output
Perfect Competition
An outward shift in supply leads
to lower prices for consumers
Firm’s Output
Short-run Profit maximization
Price
Industry
Individual firm
Price
MC
Ms
AC
AR=MR
P1
Profit
Md
Industry Output
Perfect Competition
Q1
Firm’s Output
Long-run Adjustment Process Under Competition
Price
Industry
Price
Ms
Individual firm
MC
AR=MR
P1
AC
AR2=MR2
Md
Industry Output
Perfect Competition
Firm’s Output
Long-run Adjustment Process Under Competition
Industry
Price
Price
Ms
Individual firm
MC
AR=MR
P1
AC
AR2=MR2
Md
MS2
Industry Output
Perfect Competition
Firm’s Output
Long-run Adjustment Process Under Competition
Industry
Price
Price
Ms
Individual firm
MC
AR=MR
P1
AC
AR2=MR2
Md
MS2
Industry Output
Perfect Competition
Firm’s Output
Long-run Adjustment Process Under Competition
Industry
Price
Price
Ms
Individual firm
MC
AR=MR
P1
AC
AR2=MR2
Md
MS2
Industry Output
Perfect Competition
Firm’s Output
Long-run Adjustment Process Under Competition
Industry
Price
Price
Individual firm
MC
Ms
AR=MR
P1
AC
P2
AR2=MR2
Md
MS2
Industry Output
Perfect Competition
Q2
Q1
Firm’s Output
Short-run Losses
MC
Price
Industry
Price
AC
Individual firm
Ms
AR=MR
Loss
P1
Md
Industry Output
Perfect Competition
Q2
Firm’s Output
Long run equilibrium
Perfect Competition