1. ECON 211 ELEMENTS OF ECONOMICS I
Session 6– Perfect Competition (Part 3)
Lecturer: Dr. (Mrs.) Nkechi S. Owoo, Department of Economics
Contact Information:

2. Session Overview
This session is the first of two that analyze different market structures. Market structure is a way of describing those characteristics of a market that influence the behavior of buyers and sellers when they come together to trade.
To determine market structure, we must ask how many buyers and sellers are in the market, whether the product is standardized, and whether there are barriers to entry.
The answers to these questions help to classify a market into one of four basic types: perfect competition, monopoly, monopolistic competition, or oligopoly.
This session concludes the discussion on perfectly competitive markets.

3. Session Outline
The key topics to be covered in the session are as follows:
Perfect Competitive Firms in the long run

4. Reading List
Hall and Lieberman
Chapter 8, pp:

5. Perfectly competitive firms in the long run
Topic One
Perfectly competitive firms in the long run

6. Long-Run Competitive Equilibrium
Profits and losses are inconsistent with long-run equilibrium.
Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made.
Only zero profit will stop entry.

7. Competitive Markets in the Long Run
New firms can enter the market
Existing firms can exit the market
Profit and loss in the long run
When Economic profits exist, outsiders enter the market
When Economic losses exist, existing firms exit the market

8. Long-Run Competitive Equilibrium
The existence of losses will cause firms to leave the industry.
Zero profit condition is the requirement that in the long run zero profits exist.
The zero profit condition defines the long-run equilibrium of a competitive industry.

9. Illustration: From SR Profit to LR Equilibrium
See the illustration on the next slide on long run equilibrium when firms begin with some profits in the short run
Economic profit attracts new entrants
Market supply curve - shift rightward
Market price - falls
Demand curve facing each firm - shifts downward
Each firm - decrease output
Positive economic profit - attracts new entrants until economic profit = 0

10. Illustration: Long-Run Equilibrium
Price per bagl
Market
Bags of maize
Ghcs
Firm S1
so each firm earns an economic profit. MC
With initial supply curve S1, market price is $4.50… A A
4.50
4.50 d1
ATC D
900,000
9,000

11. Illustration: Long-Run Equilibrium
From Short-Run Profit to Long-Run Equilibrium
Market
Firm S1 S2
Price per Bushel
Dollars MC A A
$4.50
$4.50 d1
ATC E E
2.50
2.50 d2 D
900,000
1,200,000
5,000
9,000
Bushels per Year
Bushels per Year
until market price falls to $2.50 and each firm earns zero economic profit.
Profit attracts entry, shifting
the supply curve rightward…

12. From SR Loss to LR Equilibrium
What happens to long run equilibrium when firms begin with some losses in the short run
Economic losses - firms exit the market
Market supply curve - shift leftward
Market price - rises
Demand curve facing each firm - shifts upward
Economic loses – firms exit until economic loss = 0
In the LR, firms earn “normal profit” - zero economic profit
Show with a Graphical Illustration

13. Why Do Competitive Firms Stay in Business If They make Zero Profit?
Explanation?

14. Why Do Competitive Firms Stay in Business If They make Zero Profit?
Zero economic profits not the same as zero accounting profits
When firm makes zero economic profits, still makes positive accounting profits
Accounting profit just enough to cover all farmer’s opportunity/implicit costs
Illustration
Suppose a farmer paid Ghc100,000 for a maize farm and works 40 hours a week
Suppose that Ghc100,000 could have been invested to earn Ghc6,000 per year
Farmer could have also worked somewhere else and earned Ghc50,000 a year
Then farmer’s implicit costs is Ghc56,000
Therefore, zero economic profits= farmer earning Ghc56,000 in accounting profits each year!
Competitive firms stay in business because they can do no better elsewhere!!

15. Is Perfect Competition Realistic?
What do you think?

16. Realistic? Most products have some degree of differentiation
Therefore, the assumption of standardized products can be problematic
Significant barriers to entry
Start-up costs, govt regulations (utilities), etc
Therefore, the assumption of easy entry and exit can be problematic
Buyers not fully aware of all aspects of products
This violates the assumption of perfect knowledge that the model of perfect competition assumes
Can you think of any more limitations of the perfectly competitive market?

17. Is Perfect Competition Realistic?
Many markets - while not strictly perfectly competitive - come reasonably close
Perfect competition can approximate conditions and yield accurate-enough predictions in a wide variety of markets
Therefore, this model remains useful in modeling firm behaviour, despite some unrealistic elements

18. References
Economics: Principles and Applications: Hall R.E. and Lieberman M. (2008), Thomson/ South Western (4th Edition)