8 Perfect competition

Market Dynamics

  • Markets are systems connecting buyers and sellers of products.

  • Fair competition exists when many buyers and sellers lead to optimal choices based on price, quality, and value.

  • Unfair competition arises from actions against public interest, such as cartels and monopolies.

Capacity Utilization

  • Higher capacity utilization reduces production costs.

  • Excess capacity can lead to required rationalization within the industry.

Characteristics of Perfect Competition

  • Many firms sell identical products and have equal market access.

  • Buyers are informed about product pricing, making firms price takers.

Economic Metrics

  • Total Revenue (TR) = Price (P) × Quantity (Q)

  • Marginal Revenue (MR) = change in TR from selling one more unit.

  • Average Revenue (AR) = TR / Q, where in perfect competition, Price = MR = AR.

Firm Decisions

  • Short-run: decide to produce or shut down, and determine production quantity.

  • Long-run: adjust plant size and determine industry entry/exit.

Profit Maximization

  • Marginal analysis: Compare MR to Marginal Cost (MC) to adjust output for profit maximization.

  • Economic profit occurs when TR exceeds Total Cost (TC).

Short-run and Long-run Equilibria

  • Short-run equilibrium: firms earn profit, break-even, or incur losses based on TR and TC.

  • Long-run equilibrium occurs when firms earn normal profit; firms neither enter nor exit.

Adjustment Mechanisms

  • Entry and exit of firms adjust industry prices and profits.

  • Changes in technology can shift costs and draw new firms into the market, affecting supply and demand.

Efficiency in Perfect Competition

  • Efficient allocation of resources occurs when there are no external benefits or costs.

  • Perfect competition leads to optimal consumer surplus and producer surplus, avoiding underproduction or overproduction of goods.

  • Monopoly restricts output below competitive levels, raising prices and profits at the expense of efficiency.