Econ 1 (Perfect Competition)

There are many buyers and sellers in the market

One firm in a perfectly competitive market produces only a negligible amount of the total quantity of the commodity provided in the market. If any one firm decides to produce and sell more, this decision does not substantially alter market conditions.

Each firm in the market produces identical products

All firms produce a standardized or homogeneous commodity, which means the commodity produced by one firm is no different from a commodity produced by any other firm.

Buyers and sellers have perfect information

The good's price and quality are known to all buyers and sellers.

There is free entry into and exit from the market

There are no barriers to entry in a perfect competition. Therefore, new firms can easily establish themselves in the market. Existing firms can also easily exit the market. The assumption of free entry and exit simply implies that additional firms can enter the market if economic profits are being earned, and firms are free to leave the market if they are sustaining losses.

Price taker

When a firm is a price taker, price is established through supply and demand in the market. The perfectly competitive firm then sells its product at the market-established price. The firm cannot set the price. Under these conditions, a firm can only determine the output they must produce to maximize profits, and what inputs to use to minimize costs.

Advantages of Perfect Competition

Because there is perfect knowledge, there is no information failure and knowledge is shared evenly between all participants.

Advantages of Perfect Competition

There are no barriers to entry, so existing firms cannot derive any monopoly power.

Advantages of Perfect Competition

Only normal profits are made, so producers just cover their opportunity cost.

Advantages of Perfect Competition

There is no need to spend money on advertising, because there is perfect knowledge and firms can sell all they produce. In addition, selling unbranded goods makes it hard to construct an effective advertising campaign.

Disadvantages of Perfect Competition

Firms do not have an incentive to innovate, or spend on research and development because their products can be easily copied by other firms.

Disadvantages of Perfect Competition

Since the firms produce the same product, there is less variety.

Disadvantages of Perfect Competition

Firms do not enjoy economies of scale (fall in the long run average total costs because of an increased scale of production), if they did, only a few large firms would remain in the industry.

P>ATC

supernormal profits

P=ATC

breaks even, and the firm makes normal profits.

P<ATC

suffers a loss, because the price cannot cover the average costs.

Shutdown

is the short-run decision not to produce anything because of market conditions.

Exit

is the long-run decision to leave the market.

Shuts down

A firm that _____ temporarily must still pay its fixed costs.

Exits

A firm that _____ the market does NOT have to pay any costs at all, fixed or variable

TR<VC

It chooses to shut down under three (3) conditions

TR/Q<VC/Q

It chooses to shut down under three (3) conditions

P<AVC

It chooses to shut down under three (3) conditions

right

In the long run, outsider firms are attracted to the industry if the firms are making supernormal profits. This is because there are no barriers to entry and because there is perfect knowledge. The effect of this entry into the industry is to shift the industry supply curve to the _____, which drives down prices until all supernormal profits are exhausted.

left

If the firms are making losses, they will leave the market as there are no exit barriers, and this will shift the industry supply to the left, which raises price and enables those _____ in the market to have normal profits

Economic profit/supernormal profit

is based on all the production costs

Zero economic profit

represents a normal rate of return for your business, if the economic profit is greater than zero, the business is earning more than the normal return.

Zero economic profit

means that price equals average total cost.

Description of the long run equilibrium

The quantity of the product supplied in the market equals the quantity demanded by all consumers.

Description of the long run equilibrium

Each firm in the market maximizes its profit, given the prevailing market price.

Description of the long run equilibrium 

Each firm in the market earns zero economic profit (normal profit) so there is no incentive for other firms to enter the market.

Description of the long run equilibrium 

Profit maximization depends on producing a given quantity of output at the lowest possible cost

Description of the long run equilibrium

The long run equilibrium requires zero economic profit. Firms ultimately produce the output level associated with minimum long-run average total cost.