1 perfect competition 1. Many participants, buyers and sellers. 2. Sellers are infinitesimally small. 3. Homogeneous products. 4. Free entry and exit. 5. Perfect information.

2 1. Competitive Firms 1. a. In the short run almost horizontal demand. 2. b. supply curve of firm is the MC above AVC. 3. c. Industry supply horizontal sum of firms mcs (the sum of their output at a price).

3 AC 1 MC D = MRMR P* q* Short Run Profit Maximizing solution for a competitive firm; MC seems to be the supply curve. AC q* Profits

4 AVC AC supply curve of firm is the mc above avc AFC P Q q1 q2 q3 p3 p2 p1 S MC

5 supply curve of industry is the horizontal sum of each individual firm’s supply. Firm A Firm B Firm C Industry qaqa qbqb qcqc Q a+b+c p1 s s s S q a1 Q = q a1 p2

6 Competitive Equilibrium 1. a. fixed number of firms in SR!! no entry or exit allowed; therefore, industry supply can not change 2. b. for firm: d=mr=p=mc 3. c. In longer run, profits draw entry of firms, increasing industry supply, lowering price and profits down to zero; negative profits cause exit, decreasing supply, raising price and bring profit back to zero.

7 AC P "Representative" Firm in Industry P Competitive Industry This represents a competitive industry in a short run equilibrium. Meaning that until entry or exit can occur, nothing will change since the price equalizes quantity demanded and supplied. But the typical firm earns profits (right hand picture) and entry will increase industry supply in long run, lowering price. p1 qQ1Q1

8 AC P "Representative" Firm in Industry P Competitive Industry This represents a competitive industry in a long run equilibrium (price P 3 ). Once achieved, nothing will change since the price equalizes quantity demanded and supplied. Since the typical firm earns no profits (right hand picture) no further entry or exit will occur. S1 S3 p1 p2 S2 p3 Q1Q1 Q2Q2 Q3Q3 q q1q1

9 Efficiency of Competition 1. a. no deadweight losses-- i.e. on prod poss frontier 2. b. each firm at bottom of ac--- seems good, but actually irrelevant for economic efficiency 3. c. consumers vote with dollars. Popular products make money, drawing entry until enough of the product is produced. The drive for profits makes firms efficient and efficient firms drive out inefficient firms (Darwin and Economics).

10 AC P "Representative" Firm in Industry P Competitive Industry The right hand diagram represents the typical firm in long run equilibrium. The firm is at the bottom of the AC, meaning that costs are minimized. Industry has zero deadweight loss. q 1 2 CS=1 PS=2

11 Efficiency of Competition (rpt) 1. a. no deadweight losses-- i.e. on prod poss frontier 2. b. each firm at bottom of ac--- seems good, but actually irrelevant for economic efficiency 3. c. consumers vote with dollars. Popular products make money, drawing entry until enough of the product is produced. The drive for profits makes firms efficient and efficient firms drive out inefficient firms (Darwin and Economics).

12 Competitive Markets that aren’t 1. Example of taxi-cab medallions 2. Television station licenses. 3. Medical doctors 4. Many, many, more.

13 Long Run Supply: No External Effects 1. Competitive industry must have constant costs in this case. 2. Long run industry supply must be horizontal at the bottom of the AC of representative firm. 3. Long run industry output changes only through entry and exit of new firms.

14 AC P "Representative" Firm in Industry P Competitive Industry The typical firm in long run equilibrium at the bottom of its AC, meaning that costs are minimized. With no external effects, each firm always produces ‘q’ and long run industry output only changes when the number of firms changes. q LRS SRS P1P1

15 Long Run Supply with External Effects 1. Competitive industry may have increasing or decreasing costs in this case. 2. Long run industry supply changes only as the bottom of the AC of representative firm changes.

16 P Q AC for representative firm as industry output Q increases. AC (Q1) AC (Q2) AC (Q3)

17 P Q Q1 Q2 Q3 Long run supply in decreasing cost competitive industry AC (Q1) AC (Q2) AC (Q3) LRS