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Chapter 9

ECON-UA 2 Chapter Notes - Chapter 9: Demand Curve, Market Power, Perfect Competition

Course Code
Marc Lieberman

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What are the 4 characteristics of Perfect Competition?
There are large numbers of buyers and sellers, and each buys or sells only a tiny fraction of the
total quantity in the market.
Sellers offer a standardized product.
Sellers can easily enter into or exit from the market.
Buyers and sellers are well-informed.
Large Number of Buyers and Sellers
In a perfectly competitive market, the number of buyers and sellers is so large that no individual decision
maker can significantly affect the price of the product by changing the quantity it buys or sells.
A Standardized Product
Buyers do not perceive differences between the products of one seller and another
Easy Entry into or Exit From the Market
A perfectly competitive market has no significant barriers or special costs to discourage new
entrants: Any firm wishing to enter can do business on the same terms as firms that are already
Perfect competition also requires easy exit: A firm suffering a long-run loss must be able to sell
off its plant and equipment and leave the industry without obstacles
Well-Informed Buyers and Sellers
In perfect competition, both buyers and sellers have all information relevant to their decision to buy or sell.
For example, they know about the quality of the product and the prices being charged by competitors.
Why is the perfect competition model the most-used model in Economics?
First, using simple techniques, it leads to important predictions about a market’s response to
changes in consumer tastes, technology, and government policies.
Second, many markets, while not strictly perfectly competitive, come reasonably close.
Describe the Demand Curve Faced by a Perfectly Competitive Firm
A perfectly competitive firm faces a demand curve that is horizontal (perfectly elastic) at the market price.
In perfect competition, the firm is a price taker: It treats the price of its output as given.
Relationship between MR and Demand
With perfectly competitive firms, the MR curve IS the demand curve, as each unit the firm sells goes for
the same amount of money (so the demand curve is a line at the market price)
Do you use the same techniques with TR, TC, MC, and MR to find profit maximizing outputs of perfectly
competitive firms?
Yes, the same rules for finding the profit maximizing output (both graphically or algebraically) apply
Profit per Unit
P, ATC, and Profit
A firm earns a profit whenever P > ATC. Its total profit at the best output level equals the area of
a rectangle with height equal to the distance between P and ATC, and width equal to the
quantity of output.
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A firm suffers a loss whenever P < ATC at the best level of output. Its total loss equals the area
of a rectangle with height equal to the distance between P and ATC, and width equal to the
quantity of output.
Supply curves and MC curves
-As the price of output changes, the firm will slide along its MC curve in deciding how much to produce.-
This is because with perfectly competitive firms, the supply curve is the MC curve for all prices above the
shut down price
Shutdown Price
Price at which a firm is indifferent about shutting down or staying open (P=AVC), since it will shut down at
any price lower and stay open at any price higher.
Shut Down Rule
If P < AVC, shut down, produce 0 unitsIf P=AVC, a firm is indifferent about shutting down or continuing to
operateIf P> AVC, don't shut down
Where is the shut down price
At the minimum of the ATC curve
In the short run, the number of firms in the industry is.....
How do we find the market supply curve for a perfectly competitive market?
To obtain the market supply curve, we add up the quantities of output supplied by all firms in the market
at each price.
In a short-run market supply curve, what are we assuming remains constant as we move along the
The fixed inputs of each firm
The number of firms in the market
In short-run equilibrium, competitive firms can earn
An economic profit or suffer an economic loss
Sum up Perfect Competition
In perfect competition, the market sums up the buying and selling preferences of individual consumers
and producers, and determines the market price. Each buyer and seller then takes the market price as
given, and each is able to buy or sell the desired quantity.
In the long run, new firms
can enter a competitive market, and existing firms can exit the market.
How do firms decide to enter/exit a market in the long-run, when they can vary all of their inputs?
In a competitive market, economic profit and loss are the forces driving long-run change. The expectation
of continued economic profit causes outsiders to enter the market; the expectation of continued economic
losses causes firms in the market to exit.
In the long-run, what happens if firms in a perfectly competitive market are making a profit?
First, the profitable market will attract new firms, which will shift the supply curve to the right. That causes
the market price to fall, lowering the demand curve for each firm. Each firm will continuously decrease
output until each firm is earning 0 economic profit.
In the long-run, what happens if firms in a perfectly competitive market are suffering a loss?
In a competitive market, economic losses continue to cause exit until the losses are reduced to zero.
Normal Profit
In the long run, the competitive firm will earn normal profit—that is, zero economic profit.
How do firms decide their plant size?
In long-run equilibrium, a competitive firm will operate with the plant and output level that bring it to the
bottom of its LRATC curve.
Summary of the competitive firm in the long-run
In long-run equilibrium, the competitive firm operates where:> MC = minimum ATC = minimum LRATC =
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How do perfectly competitive firms benefit consumers?
In the long run, each firm is driven to the plant size and output level at which its cost per unit is as low as
Short-run impact of an increase in demand in competitive markets
a rise in market price,
a rise in market quantity
economic profits
Constant Cost Industry
A change in industry output (such as when new firms enter) has no impact on the cost curves of the
individual firm
Constant Cost Industry in the long-run
In a constant cost industry, in which industry output has no effect on individual firms’ cost curves, the
long-run supply curve is horizontal. In the long-run, the industry will supply any amount of output
demanded at an unchanged price.
Increasing Cost Industry
The entry of new firms that use the same inputs as existing firms drives up input prices. This, in turn,
causes each firm’s LRATC curve to shift upward, so that zero economic profit occurs at a higher price.
The long-run supply curve slopes upward.
Decreasing Cost Industry
A rise in industry output causes input prices to fall, and the LRATC curve to shift downward at each firm,
so that zero economic profit occurs at a lower price. The long-run supply curve slopes downward.
Market Signals
When changes in price are used by new firms to decide whether or not to enter/exit an industry
In a market economy, price changes act as market signals, ensuring that the pattern of
production matches the pattern of consumer demands. When demand increases, a rise in price
signals firms to enter the market, increasing industry output. When demand decreases, a fall in
price signals firms to exit the market, decreasing industry output.
What happens with a technological advancement?
Under perfect competition, a technological advance leads to a rightward shift of the market supply curve,
decreasing market price. In the short run, early adopters may enjoy economic profit, but in the long run,
all adopters will earn zero economic profit. Firms that refuse to use the new technology will not survive.
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