3.4.2 Perfect competition

Different types of markets

Characteristics of perfect competition (perfect competition is the idealised market model to compare but impossible to happen in real life lol)

• Number of firms: many small sellers & buyers (near infinite) (all firms equally small in size)

• Type of product: homogenous product (all firms produce the same product - perfect substitutes)

• Knowledge: Perfect knowledge (everyone knows everything equally about the market)

• Barriers to entry/exit: No, costless

• Price-setting ability: None, price taker (this is because all firms sell the exact same good - so can’t determine price of good)

• Objective: Profit maximisation

Revenue in perfect competition

Supernormal profits in short run & long run for perfect competition

Short run:

• Supernormal profit only happens in short-run, in long run, no supernormal profit only normal profit

• This is because:

  • In short run, supernormal profit attracts new firms to industry → AR decrease (=AR=D=P) → this AR straight line continue to shift down as more firms enter due to no barriers to entry → shift down until land on normal profit so no supernormal profit anymore in long run→ stay there because no firms want to enter industry anymore as they see no profit

    • In short run, not productively efficient but allocatively efficient & dynamically efficient

• Therefore, in long run, firms are productively & allocatively efficient (measure from prof max point) but not dynamically efficient (no supernormal profit)

Profit maximizing equilibrium in the short run & long run

Profit maximizing equilibrium in the long run

Sub-normal profits in short run

Sub-normal profits in long run

How to calculate (profit) loss per unit from the graph

Profit = Revenue - Cost

Profit loss per unit = Revenue per unit - cost per unit

1) Revenue = p x q

2) Therefore, revenue per unit = price

3) Cost per unit = TC/Q = AC

Therefore, profit loss per unit = AC - P

How to calculate profit per unit from the graph

P - AC

Shutdown point

• Long run shutdown condition:

  • AR less then AC

• Short run

  • AR less than AVC → shutdown

  • AR more than AVC (but less than AC) → carry on