CHAPTER 11

Market Structure : Perfect

Competition

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Market Structure
 Type of market structure influences how a
firm behaves:
 Pricing
 Supply
 Barriers to Entry
 Efficiency
 Competition
Market Structure
 Determinants of market structure
 Barriers of entry and exit
 Nature of the product – homogenous (identical),
differentiated?
 Nature & Size Distribution of Sellers
 Nature & Size Distribution of Buyers
 Information flow
Market Structure
 Perfect Competition:
 Free entry and exit to industry
 Homogenous product – identical so no consumer
preference
 Large number of buyers and sellers – no individual seller
can influence price
 Sellers are price takers – have to accept the market
price
 Perfect information available to buyers and sellers
Market Structure
 Examples of perfect competition:
 Financial markets – stock exchange,
currency markets, bond markets?
 Agriculture?
 To what extent?
Market Structure
 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
Market Structure
 What happens in a competitive
environment?
 New idea? – firm makes short term abnormal profit
 Other firms enter the industry to take advantage of
abnormal profit
 Supply increases – price falls
 Long run – normal profit made
 Choice for consumer
 Price sufficient for normal profit to be made but no more!
Review: Short-Run Cost Curves
Cost MC
($ per unit)
AC

AVC

Output
Cost
($ per unit)
AFC = AC – AVC

AFC
Output
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 Short-Run Profit Maximization

Under perfect competition, firms are “price takers.” They can

sell all they choose, at the market price.
Box 2. Total Revenue, Total Cost, and Profit

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Box 3. Output, Total Revenue, and Marginal
Revenue for a Competitive Firm

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Box 4. Marginal Cost Calculated from Total Cost
for a Competitive Firm

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Box 5. Marginal Analysis for Profit Maximization

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Box 6. Profit
Maximization
by a
Competitive
Firm

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Box 7. A Competitive Firm in Equilibrium Earning
Zero Profit

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Box 8. A Competitive Firm Incurring Losses

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Box 9. The Shutdown Point

The firm’s shutdown price is the price at which

the firm is indifferent between operating and
shutting down.
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The Long Run
 The short run is a timeframe in which at
least one of the resources used in
production cannot be changed.

 Exit and entry are long-run phenomena.

 In the long run, all quantities of resources

can be changed.
Adjustments in the Long Run
 If economic profits are present new firms
will come into the industry
 The Market price will fall
 The profit shrinks
 Input prices may go up
 Firms try to stay profitable by taking
advantage of economies of scale
 Firms adopt an optimal size
 Economic profits tend toward zero
 Figure: From Short-Run Profit To
Long-Run Equilibrium
Market Firm

Price per S1
Dollars So each firm
Bushel With initial supply earns an MC
A curve S1, market economic profit.
price is $4.50… A
$4.50 $4.50 d
ATC 1

900,000 Bushels 9,000 Bushels

per Year per Year
 Figure: From Short-Run Profit To
Long-Run Equilibrium
Market Firm

Price per S1 S2
Dollars
Bushel MC
A
A
$4.50 $4.50 d
ATC 1

E E
2.50 2.50 d1
D

900,000 1,200,000Bushels 5,000 9,000 Bushels

per Year per Year
Profit attracts entry, shifting until market price falls to
the supply curve rightward… $2.50 and each firm earns
zero economic profit.
Long-Run Competitive Equilibrium
Graph
P At long-run equilibrium,
economic profits are zero MC

LRATC
SRATC

P = D = MR

14-22
Long-Run Equilibrium
 P = MC results from the assumption that
firm’s are profit maximizers.
 P = AC results because market forces cause
long run economic profits to equal zero.
 In the long run, firm owners will only earn
normal returns on their investments.