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Topic 8 - Perfect Competition.docx

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Economics 1021A/B
Arvin Dar

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Topic 8 – Perfect Competition 1. Introduction 2. Possible SR equilibria for a firm 3. SR S curve for a firm and for the industry 4. LR equilibrium for this market structure (for firms operating under it) 5. Question of efficiency 1. Introduction Conditions needed: 1. We have many sellers 2. We have very easy entry 3. We have a product that is homogenous (i.e. cannot be differentiated – gay couple) 4. We have perfect information (i.e. everybody is aware of everything going on – all know prices) 5. Costless transaction (at the minimum, the same cost transaction) (Cost A = Cost B [driving, etc.]) Industry/Market Firm (D = perf elastic)  Why does the firm act like a price taker? o Industry decides the price of a bushel of wheat. Suppose its $10. The farmer decides to sell for $11. Perfect information, everyone will know he’s selling at $11. The buyers know everyone else is selling at $10. Since it’s a homogeneous product with many sellers, people will buy somewhere else. o Farmer decides to sell wheat at $9. Immediately everyone’s going to know that and rush to his farm, line up outside his farm to buy his wheat. Someone’s going to offer to buy it all for $9 so he can resell it for $10 and he’s going to have to turn other people away. o The price has to be the price the industry sets. o When there are many sellers, each individual seller is insignificant. 2. Possible SR equilibria for a firm  There are three possible short run equilibria for a firm operating under perfect competition. One where the firm makes positive profits, one where the firm makes zero profits, and one where the firm earns negative profits.  In the latter case, the firm may or may not shut down. $P, MR, AC, MC MC AC MC AC P* P=D=AR=MR AC*  P ≥ AVC  MC = MR MC cuts MR from below Q* Q Q* If P > AC (AFC + AVC) then P > AVCP = TR and AVC = TVC AC/1 = TC/Q means TC = Q*AC AC AVC AC MC AVC Close. P won’t cover TVC, not to mention TFC  MC = MR  Cut MR
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