L14 perfect comp

Microeconomics Overview

• Course: ECA002

• Topic: Perfect Competition

• Lecturer: Luke Garrod

Aims of Market Structure Lectures

• Before Christmas: Analyzed buyer and seller behavior in markets.

• Now: Integrating both sides with previous supply & demand analysis.

• Purpose of revisiting:

  • Positive aspects: production levels and pricing.

  • Normative aspects: assessing goodness of these outcomes.

• Market Structure Definition:

  • It encompasses characteristics affecting trades, including:

    • Number and size of sellers.

    • Barriers to entry.

    • Product differentiation.

    • Number and size of buyers.

Quick Exercise

• Compare markets for bottled mineral water and cola:

  • Number and size of sellers.

  • Barriers to entry.

  • Product differentiation.

  • Number and size of buyers.

Aims of the Lecture

• Focus: Perfect Competition

• "Perfect" indicates market conditions, not quality.

• Assumptions: Often unrealistic, hard to find real-world examples.

• Importance of study:

  • Insight into agricultural and financial markets.

  • Extremes help form foundational understanding.

  • Investigate output production and pricing in perfect competition.

Lecture Outline

1. Two rules for profit maximization (review Topic 3).

2. Fundamental assumptions.

3. Appropriate market structure.

4. Short-run equilibrium.

5. Long-run equilibrium.

• Reading Material: Lipsey & Chrystal, chapter 6.

Reminders: Profit Maximization Rules

1. Marginal Output Rule

• If firm continues production:

  • Condition: MR = MC (marginal revenue equals marginal cost).

  • Reasoning: Producing an extra unit is beneficial if MR > MC, increasing total revenue and profit.

2. Shutdown Rule

• Firm should shut down if:

  • For any output level: p < AC (average cost).

  • Short-Run Condition: p < AVC (average variable cost).

  • Long-Run Condition: p < LRAC (long-run average cost).

Assumptions of Perfect Competition

A(1) Buyers are Price Takers

• Buyers accept market prices without influence.

A(2) Complete Information

• Sellers respond to market incentives.

• Buyers have optimal purchasing opportunities.

A(3) Sellers are Price Takers

• Sellers perceive their output does not affect market price.

  • Selling as much as desired at a given price.

  • Output choices do not provoke rival responses.

A(4) Free Market Entry

• Potential sellers can enter without existing costs, thus:

  • Long-run entries involve changes in all production factors.

  • Entry supports market competition with no capital barriers.

Market Structure Characteristics

• Size and Number of Sellers: Many small sellers influence price minimally.

• Barriers to Entry: Low; firms must enter freely.

• Product Substitutability: Homogeneous products lead to price competition.

Short-Run Equilibrium Under Perfect Competition

• Definition: Equilibrium occurs when:

  • Sellers produce exactly what buyers wish to purchase.

  • Established through market supply and demand.

  • Market price is set where supply and demand curves intersect.

Seller's Supply Curve and Market Supply Curve

• Equilibrium Price (p): Establishes output levels by employing marginal output and shutdown rules.

• Market Supply: Derived from total outputs of numerous symmetric sellers.

General Case of Short-Run Equilibrium

• Market interactions dictate equilibrium as price adjusts to changes in demand and supply.

Long-Run Equilibrium in Perfect Competition

1. Long-run adjustments allow for freely adjusted production costs.

2. Conditions ensuring equilibrium:

   • Sellers continue selling based on market demand.

   • Zero economic profits at equilibrium as sellers neither enter nor exit.

Long-Run Equilibrium Characteristics

• Prices equate average costs at their minimum, indicating:

  • Normal profits realized as firms stabilize.

Lecture Summary

• Short-Run Dynamics: Price reflects production costs; firms can yield supernormal profit.

• Long-Run Dynamics: Price equals average cost, supporting only normal profits.

• Learning Objectives:

  • State assumptions of perfect competition.

  • Describe market structure relevant to these assumptions.

  • Derive short- and long-run equilibrium graphically.