402 Perfect Competition

We begin with the first type of market structures, the extreme end of the spectrum in terms of how perfect the market can be, the Perfect Competition market structure. We now build upon the foundation of consumer and firm behavior with respect to the dynamics of demand versus supply.
By definition, a Perfect Competition market structure is one where the participants are not powerful enough to set the prices for a homogenous product. It competes in the sale of a homogenous good and can only sell at one price, which is the equilibrium price determined by the clash of demand and supply. And because information mobility is assumed to be perfect, it is given that all the players, sellers and buyers, are aware of this equilibrium price.
Do you remember hearing the words “free market” back in secondary school? You would encounter it in social studies where our textbooks would tell us that governments and unions are striving towards a “free market” as that would benefit businesses and consumers. Have you ever asked yourself why this would benefit everybody?
The notion of a “free market” also means that buyers and sellers are free to enter or leave the market at their own discretion and without any barriers to entry. The influx of competitors would then affect the cost of production because of the increase in demand for production materials such as labor, capital, etc.
The question of why a perfect market would benefit society is answered with the concept of allocative efficiency, which is concerned with general equilibrium in the later chapters of this unit and Quickienomics will be covering that topic when the time comes.
I hope you enjoy the study of market structures because it has given me much insight to the business world, a dog-eat-dog world where only the fittest survive!
At the end of this video, you should be able to:

  • Relate the concept of Perfect Competition to real life examples.
  • Identify the 2 scenarios in exam questions when discussing Perfect Competition.
  • Describe the initial equilibrium.
  • Use necessary notations.
  • Differentiate between the short run and long run.
  • Analyze taxation imposed on consumers.


Notes:
Approach to Graph Dynamics (2 sellers/2 buyers):

  • Initial Equilibrium
  • Identify Economic Disturbances
  • Show immediate graph changes
  • Describe Short Run Equilibrium
  • End of Short Run
  • Identify Entrance/Exit of Firms
  • Shift Supply Curve drastically
  • Identify Increase/decrease in cost of production
  • Shift cost curves accordingly SLIGHTLY
  • Shift Supply curve to force Normal Profit
  • Describe Long Run Equilibrium
  • End of Long Run

***Be flexible with the approach as this is only the basic model of how the question should be answered. Always be alert as there might be new scenarios thrown at you.

Some extra stuff:


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Author: admin

32 Comments

  1. bhawna says:

    wouldnt mc decrease coz of the subsidy ?

    • Quickienomics says:

      Hello! When there is a lump sum subsidy, MC does not change. MC will only change if there is a per unit subsidy or decrease in variable costs. 🙂

  2. bhawna says:

    ohk ..thank you 🙂

  3. tommy says:

    Hi, on your previous video, you mention that when there is unit tax, the AC shifts up while the output remains at the same point. But in this video, you mention that where there is lump sum subsidy, it shifts down and to the left. (It’s on a video made to clarify your mistaken by your NUS friend.)Can you explain? And also, I understand that firms will continue to enter the industry until normal profit is achieved, then if this is the case, can I just shift my MC and AC curve back to where it begins? Which was originally at normal profit?
    I hope you get what I’m saying.

    • Quickienomics says:

      Hi Tommy,

      You’re wondering about the difference between a per unit tax and a lump sum tax is it? The reason for the difference is because the per unit tax is a special form of variable cost that has to be accounted for ON TOP of all the material and labor costs. You see, when firms buy materials or bulk, they get bulk discounts thus making it cheaper when they purchase or hire more. But for this per unit tax, it is uniform throughout; the per unit cost of the tax is still the same no matter how many goods you produce. Therefore, we need to add in a separate entity for it, which is t.x.

      Regarding the firms going back to normal profit. It depends on what the question wants. If there’s no other way to change the price level by changing either market demand or market supply, you can actually shift your cost curves. The assumption here is that the enter or exit of firms will causes either an increase or decrease in the demand for production factors respectively. And when we talk about production factors, we are referring to labor and capital. so therefore, you can shift your cost curves to show them move back towards normal profit.

      I hope that helps, Tommy. 🙂

  4. irene says:

    HI, can you show us import and export case under perfect competition mkt structure?

  5. irene says:

    Hi, sorry i mean question about international trade between 2 economy? eg Qun3 UOL09ZA,
    The supply of wine to a local market comes from local growers and from new and rising
    international suppliers. International supply is perfectly elastic and the local market is
    competitive. Due to good weather in other parts of the world, the price of foreign wines
    has fallen.
    (a) Describe the initial long run equilibrium, identifying the equilibrium price and
    quantity, the level of imports and the level of each grower’s output.
    (b) What will be the effects of the change on equilibrium price and quantity, imports and
    the number of growers in the industry in the short and in the long run?
    (c) Will the change have any effect on other industries assuming that the labour market
    is competitive?
    (d) To avoid a meltdown of local production, the government proposes to offer a lump
    sum subsidy to growers to prevent any one of them leaving the market. Would the
    average subsidy per unit (at the initial level of production) be greater or smaller than
    the fall in the international price? Analyse the effects of such a policy if it is pursued
    immediately in response to the fall in the international price of wine. Would your
    answer to (c) be different in this case?
    I wish to understand what the important steps to deal with this kind of question, you dont need to go through everything, it costs your time. Can you just show me how to deal with it briefly?
    Thanks so much

  6. irene says:

    thanks so much

  7. Arek says:

    Hi there!

    To clarify:
    When new competitors enter the market then demand for production factors increase. This will cause increase of costs of production because prices of production factors will increase. To show this changes we move MC curve to the left and AC curve move up.
    Am I right?

    When firms are leaving the market can we say that all these things work in the opposite way?

  8. Romona says:

    Hey there,

    I know you have spent a lot of time on Irene’s question, but could you say how you would answer the part about the labour market? I am thinking that with workers being laid off, then there would be excess supply in the labour force, so this will cause the price of labour to fall, which means that other industries in the economy will enjoy a decrease in real cost (i.e isocost shift outward). If the subsidy is immediately put into effect, then the other industries will not be affected, right?

    Thanks much, your videos have been an enormous help to me!

    Romona

    • Quickienomics says:

      Hi Romona,

      Your assumptions will definitely spice up your answer, making it more robust and realistic. However, that is going to make your answer pretty messy at the same time too. You also risk deviating from answering the question. If you have the time and the ideas to make your answers presentable, then by all means, please do so. 🙂 Your assumptions are true, but I can also state an assumption that the change in labour supply was insignificant, resulting in no change in the wage rate. This is definitely going to save me more time.

  9. Romona says:

    Thanks for your response! This is awesome! So I have another question – in answering part b, where the price has dropped and local firms are producing at a loss – this would be in the short run right? What about the long run? I have two scenarios – one where the local firms will have to leave the market (AVC will continue to be higher than MC), so then the supply curve will be that of the international sellers – perfectly elastic; or one where they will be able to change technology and so achieve normal profits at P1 again….

    What do you think?
    Thanks,
    Romona

    • Quickienomics says:

      Hi Romona!

      I would prefer the second answer actually. 🙂 You seem to be very flexible in your thinking! Sounds good!

  10. Romona says:

    Thanks! Flexible now.. It all seem to fly out the window when I am in the exam room.. I constantly run out of time… Thanks also to Irene for posting this question….

  11. Jimmy says:

    Hi there,

    In your first video (for the two seller scenario), you explained that MC and AC of firm A will increase as a result of increased demand for production factors when new competitors enter the market in the long run. Why does MC and AC of firm B not increase as well? Surely firm B is also going after the same resources as firm A, isn’t it?

    Excellent videos by the way!

    • Quickienomics says:

      Ah okay I see where you’re getting at now.

      The reason why I left out firm B because I wanted to explain what would happen to firms who experience consistent losses in the long run. You’re right to say that they are using the same resources. But I can also argue that the structure of their operations may be different, thus leading to different amounts of labor and capital used.

  12. rev says:

    if unit tax or subsidy is an addition to mc …. is ac affected ?

  13. Parag says:

    Hey there,
    What are the producer and consumer surplus?

  14. Snow says:

    In your video 1, the point b in type A, why not at the lowest point of AC which MC cross through?
    As per my understanding, the profit of type A attract from to enter the market and share that profit unit earning zero.
    If the point b of type A at ha level, firm A will produce at which MR=MC, then type A still earning profit which MR(P) is a little bit higher than AC.

    Am I correct?

  15. ashton says:

    Hi there,

    Can I know why for perfect competition firms, they will always end up with normal profit?

    • Quickienomics says:

      Hi Ashton, please forgive me for such a late reply. The reason is because there are so many players and competitors that all of them do not have monopolistic power, therefore cannot control the price. The only way to stay in the competition is to keep cutting prices. and the competitors cut their prices till the price is equal to their average and marginal cost. Those that have the lowest costs will remain, and this is a large number of players.

      that’s the layman explanation for it.

  16. Robert says:

    Hi!

    First – awesome vids, they help tons!

    Second, going over the first video on this page: with the 2 buyers scenario, the firm’s AC & MC shift up & left & the markets supply curve shifts right, with a new equilibrium on S1,D1, yes?

    Thanks!

  17. R says:

    Hmm.. May I ask what factor affect the AC curve and what affect would affect the Mc curve.. I always have problem deciding which one to shift… Thank 🙂