R

3.3: Perfect Competition

The Four Market Structures

Every Product Is Sold In A Market That Can Be Considered One Of The Below Market Structures:

Perfect Competition

  • Perfect Competition
  • Many Small Firms
  • Identical Products (perfect Substitutes)
  • Low Barriers To Entry — Easy For Firms To Enter And Exit The Industry
  • Seller Has No Need To Advertise
  • Firms Are “price Takers” (each Firm Has No Control Over The Price)

→ Eg. Corn, Strawberries, Milk

Monopolistic Competition

  • Imperfect Competition
  • Relatively Large Number Of Sellers
  • Differentiated Products
  • Some Control Over Price
  • Low Barriers To Entry — Easy For Firms To Enter
  • Lots Of Non-price Competition
    • Eg. Advertising

→ Eg. Fast Food Chains, Furniture Stores, Shoe Stores

Oligopoly

  • Imperfect Competition
  • A Few Large Producers (<10)
  • Identical Or Differentiated Products
  • High Barriers To Entry
  • Control Over Price (”price Makers”)
  • Mutual Interdependence
    • Firms Must Worry About The Decisions Of Their Competitors And Use Strategy

→ Eg. Cell Phones, Service Providers, Cars

Monopoly

  • Imperfect Competition
  • One Large Firm (the Firm Is The Market)
  • Unique Product (no Close Substitutes)
  • High Barriers To Entry — Firms Cannot Enter The Industry
  • Monopolies Are “price Makers” (set The Industry Price)

→ Eg. The Electric Company, De Beers

Barriers To Entry

  • A Monopoly Wouldn’t Last Long If There Weren’t High Barriers To Entry

Types Of Barriers To Entry

  1. Economies Of Scale

    1. Eg. There Is Only One Electric Company Because They Are The Only Ones That Can Make Electricity At The Lowest Cost; This Is Called A natural Monopoly

  2. Superior Technology

  3. Geography Or Ownership Of Raw Materials

  4. Government-created Barriers

    1. The Government Issues patents To Protect Inventors And Forbids Others From Using Their Invention

Demand For Perfectly Competitive Firms

  • They Must Be Price Takers Because If One Firm Charges Above The Market Price, No One Will Buy; They’ll Just Go To Other Firms Who Offer Lower Prices
  • There Is No Reason To Price Low Because Consumers Will Buy Just As Much At The Market Price
    • Since The Price Is The Same At All Quantities Demanded, The Demand Curve For Each Firm Is Perfectly Elastic (a Straight Horizontal Line)
  • For Perfect Competition, Demand = Marginal Revenue, Average Revenue, And Price
    • D = MR = AR = P

Short-run Profit Maximization

  • Firms Must Continue To Produce Until The Additional Revenue From Each New Output Equals The Additional Cost → Profit Maximizing Rule
    • Profit Maximizing Rule: MR=MC
  • Rule Applies To All Market Structures
  • Applies Only If The Price Is Above AVC
  • Rule Can Be Restated P = MC For Perfectly Competitive Firms (because MR = P)