perfect competition

Market Structures

Features of Market Structures

  • Perfect Competition

    • Type of firms: Many (undifferentiated)

    • Nature of product: Homogeneous

    • Examples: Cabbages, carrots

    • Demand curve faced by firm: Horizontal; firm is a price taker

  • Monopolistic Competition

    • Type of firms: Many / Several

    • Nature of product: Differentiated

    • Examples: Plumbers, restaurants, doctors

    • Demand curve faced by firm: Downward sloping, relatively elastic

  • Oligopoly

    • Type of firms: Few

    • Nature of product: Either differentiated or homogeneous

    • Examples: Cars, electrical appliances, soft drinks

    • Demand curve faced by firm: Downward sloping (shapes depend on reactions of rivals)

  • Monopoly

    • Type of firms: One

    • Nature of product: Unique

    • Examples: Gas and electricity companies in many countries, railways

    • Demand curve faced by firm: Downward sloping, more inelastic than in oligopoly; firm has significant control over price

Alternative Market Structures

  • Classifications based on:

    • Degree of competition

    • Number of firms

    • Freedom of entry into industry

    • Nature of product

    • Nature of demand curve

  • Main types:

    1. Perfect Competition

    2. Monopoly

    3. Monopolistic Competition

    4. Oligopoly

Assumptions of Perfect Competition

  1. Large Numbers of Sellers and Buyers:

    • Many firms; no individual firm can significantly impact price.

  2. Product Homogeneity:

    • Firms sell identical products; price can’t vary without losing customers.

  3. Firm is a Price Taker:

    • Firms accept market price; cannot control prices due to competition.

  4. Free Entry and Exit:

    • No barriers to entering or leaving the market.

  5. Profit Maximization:

    • Firms aim solely for profit maximization.

  6. No Government Regulation:

    • No external controls in the market.

  7. Perfect Mobility of Factors of Production:

    • Inputs can move freely across firms.

  8. Perfect Knowledge/Full Information:

    • Buyers and sellers have complete market knowledge.

  9. Negligible Transaction Costs:

    • Low costs for trading between buyers and sellers.

Revenue Concepts for a Price-taking Firm

  • Total Revenue (TR), Average Revenue (AR) and Marginal Revenue (MR)

    • Given a fixed price, total revenue can be calculated based on quantity sold.

    • TR = Price x Quantity sold; AR = TR / Quantity; MR = Change in TR / Change in Quantity.

Perfect Competition - Short-run and Long-run Equilibrium

  • Short-run equilibrium occurs where P = MC; firms can make supernormal profits.

  • Long-run equilibrium leads to firms earning zero economic profit as new firms enter the market, driving prices down until they equal average total costs.

Efficiency in Perfect Competition

  • Allocative Efficiency: Maximization of consumer and producer surplus at competitive equilibrium.

  • Consumer surplus is the area above the price line, and producer surplus is below the price line.

  • Efficiency achieved when market price equals the marginal cost and firms operate at minimum average total cost.