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Course: Microeconomics > Unit 7
Lesson 1: Perfect competition- Introduction to perfect competition
- Perfect competition and why it matters
- Economic profit for firms in perfectly competitive markets
- How perfectly competitive firms make output decisions
- Efficiency in perfectly competitive markets
- Perfect competition foundational concepts
- Long-run economic profit for perfectly competitive firms
- Long-run supply curve in constant cost perfectly competitive markets
- Long run supply when industry costs aren't constant
- Free response question (FRQ) on perfect competition
- Perfect competition in the short run and long run
- Increasing, decreasing, and constant cost industries
- Efficiency and perfect competition
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Perfect competition and why it matters
Read about the economic ideal of perfect competition.
Key points
- A perfectly competitive firm is a price taker, which means that it must accept the equilibrium price at which it sells goods. If a perfectly competitive firm attempts to charge even a tiny amount more than the market price, it will be unable to make any sales.
- Perfect competition occurs when there are many sellers, there is easy entry and exiting of firms, products are identical from one seller to another, and sellers are price takers.
- The market structure is the conditions in an industry, such as number of sellers, how easy or difficult it is for a new firm to enter, and the type of products that are sold.
Perfect competition and why it matters
Firms are said to be in perfect competition when the following conditions occur:
- Many firms produce identical products.
- Many buyers are available to buy the product, and many sellers are available to sell the product.
- Sellers and buyers have all relevant information to make rational decisions about the product being bought and sold.
- Firms can enter and leave the market without any restrictions—in other words, there is free entry and exit into and out of the market.
A perfectly competitive firm is known as a price taker because the pressure of competing firms forces them to accept the prevailing equilibrium price in the market. If a firm in a perfectly competitive market raises the price of its product by so much as a penny, it will lose all of its sales to competitors. When a wheat grower wants to know what the going price of wheat is, they have to go to the computer or listen to the radio to check. The market price is determined solely by supply and demand in the entire market and not by the individual farmer. Also, a perfectly competitive firm must be a very small player in the overall market so that it can increase or decrease output without noticeably affecting the overall quantity supplied and price in the market.
A perfectly competitive market is a hypothetical extreme. Producers in a number of industries do, however, face many competitor firms selling highly similar goods, in which case they must often act as price takers. Agricultural markets are often used as an example.
The same crops grown by different farmers are largely interchangeable. According to the United States Department of Agriculture monthly reports, in 2015, US corn farmers received an average price of $6.00 per bushel and wheat farmers received an average price of $6.00 per bushel. A corn farmer who attempted to sell at $7.00 per bushel or a wheat grower who attempted to sell for $8.00 per bushel would not have found any buyers.
A perfectly competitive firm will not sell below the equilibrium price either. Why should they when they can sell all they want at the higher price? Other examples of agricultural markets that operate in close to perfectly competitive markets are small roadside produce markets and small organic farmers.
In this tutorial, we'll examine how profit-seeking firms decide how much to produce in perfectly competitive markets. Such firms analyze their costs. In the short run, the perfectly competitive firm will seek the quantity of output where profits are highest or—if profits are not possible—where losses are lowest. In this example, the short run refers to a situation in which firms are producing with one fixed input and incur fixed costs of production. In the real world, firms can have many fixed inputs.
In the long run, perfectly competitive firms will react to profits by increasing production. They will respond to losses by reducing production or exiting the market. Ultimately, a long-run equilibrium will be attained when no new firms want to enter the market and existing firms do not want to leave the market since economic profits have been driven down to zero.
Summary
- A perfectly competitive firm is a price taker, which means that it must accept the equilibrium price at which it sells goods. If a perfectly competitive firm attempts to charge even a tiny amount more than the market price, it will be unable to make any sales.
- Perfect competition occurs when there are many sellers, there is easy entry and exiting of firms, products are identical from one seller to another, and sellers are price takers.
- The market structure is the conditions in an industry, such as number of sellers, how easy or difficult it is for a new firm to enter, and the type of products that are sold.
Self-check questions
Firms in a perfectly competitive market are said to be price takers—that is, once the market determines an equilibrium price for the product, firms must accept this price. If you sell a product in a perfectly competitive market, but you are not happy with its price, would you raise the price, even by a cent?
Would independent trucking fit the characteristics of a perfectly competitive industry?
Review questions
- A single firm in a perfectly competitive market is relatively small compared to the rest of the market. What does this mean? How small is small?
- What are the four basic assumptions of perfect competition? Explain what they imply for a perfectly competitive firm.
- What is a price taker firm?
Critical-thinking questions
- Finding a life partner is a complicated process that may take many years. It is hard to think of this process as being part of a very complex market with a demand and a supply for partners. Think about how this market works and some of its characteristics, such as search costs. Would you consider it a perfectly competitive market?
- Can you name five examples of perfectly competitive markets? Why or why not?
Want to join the conversation?
What is the answer to the question: Can you name five examples of perfectly competitive markets? Why or why not. My understanding is that there is no such thing as a perfectly competitive market. We may get close to one, such as in the airline industry. But it is still not a perfectly competitive market. Therefore, we can't give five examples. Or, is the question asking for a "nearly" perfectly competitive market. What is being asked for here and am is my understanding correct?(11 votes)
I think mining cryptocurrency meets the criteria listed above in that:
Many firms (miners) produce identical products (cryptocurrency).
Many buyers are available to buy the product (cryptocurrency), and many sellers are available to sell the product (cryptocurrency).
Sellers and buyers have all relevant information to make rational decisions about the product (cryptocurrency) being bought and sold.
Firms (miners) can enter and leave the market without any restrictions—in other words, there is free entry and exit into and out of the market.
arguably this isn't the case for every cryptocurrency but it seems like the concept fits nicely.(13 votes)
A single firm in a perfectly competitive market is relatively small compared to the rest of the market. What does this mean? How small is small? In this question how can I explain the how small ?(2 votes)
A small firm is a firm not big enought to make any change in the equilibrium price.(12 votes)
Suppose, in a perfectly competitive market selling oranges, a seller sells at 4$ per kilo and another seller sells at 5.5$ per kilo. Now, a buyer who comes across these two sellers may think that the 5.5$ oranges are better in quality even though they're the same and may purchase the latter. By going through the fourth paragraph of the 'Perfect competition and why it matters', how can we relate to it and won't other factors like consumer psychology have a say in this?(3 votes)
If the quality of the good is different based on the supplier (or even if people think that is the case), then it is by definition not a perfectly competitive market. Perfect competition requires completely identical goods. The situation you describe would be a monopolistically competitive market where goods are slightly differentiated.(7 votes)
explain how a perfectly competitive firm can make economic (abnormal)profit only in the short run?(1 vote)- In the long run, other firms will enter the market seeking to make the same economic profit. This drives the price down until no firms have any incentive to enter because there are no economic profits.(4 votes)
Is a private school perfectly competitive or monopoly?(2 votes)- Neither. A perfectly competitive market would have no differentiation or their goods or services, which may be accurate if you were talking about a public school, and its definitely not a monopoly as there is not just one brand of private schooling, but more than one. To be honest, based on the detailed characteristics, I'd label it under a monopolistic competition(MC) or an oligopoly. If it were to be under an MC, the main criteria would be similar but differentiated goods or services, and privates schools differ from one another based on their name (their brand). However, in a not-so urban region where private schooling is not common, it may fall under an oligopoly, as it would be one of very few other organisations that provite private schooling services, possibly allowing it a decent amount of market power to be a price maker.(2 votes)
- Does manufacturing of cellphones come under perfect competition??(1 vote)
There's no such thing as completely perfect competition in real life. You need to examine the industry and ask yourself what are the characteristics of perfectly competitive markets and how closely does the cellphone industry match those.(3 votes)
Is it fair to say that in a perfectly competitive market, the supply is very inelastic? Because even a slight price increase from one firm will lead to them losing all their business to the other firms.(1 vote)- No, it is actually the opposite: a firm's supply curve is perfectly elastic. Even a slight change in price loses ALL business. Perfectly inelastic would mean a change in price results in NO business lost.(2 votes)
what is the meaning of 'market structure' here ?
and i also didn't got the meaning of sentence 'the market structure is the conditions in an industry,' . please explain that.(1 vote)- Market structure defines the various characteristics of a selected market or industry.(2 votes)
- How does a perfectly competitive market appear mainly in products?(1 vote)
- Does an inelastic demand curve cause farm prices to fluctuate more in response to supply changes than if the demand were elastic?(1 vote)