9.1

• What is Perfect Competition?

  In a perfectly competitive market, no single firm has the power to influence the price of the goods being sold. This is because there are many small firms producing identical (homogeneous) products. Therefore, all firms and consumers in this market are price takers, meaning they accept the market price as given.
• Characteristics of a Perfectly Competitive Market:

  • many sellers and buyers
  • homogenous products
  • perfect information
  • free entry and exit
• Many Sellers and Buyers:

  • There are so many firms that each one is small relative to the total market. No single firm can influence the market price.
  • The same goes for buyers; no individual buyer can dictate the price because their purchase is too small compared to the total market demand.
• Homogeneous Products:

  • The products produced by all firms are identical, which means there’s no difference between the goods offered by one firm compared to another.
  • For example, wheat or corn in agriculture – one farmer's wheat is identical to another’s.
• Perfect Information:

  • Both buyers and sellers know everything they need to know about prices, quality, and availability of products.
  • This means buyers know they can get the same product at the same price from any seller.
• Free Entry and Exit:

  • Firms can freely enter the market if they see the potential for profits or leave if they are incurring losses. There are no significant barriers like large start-up costs or heavy regulation to prevent them from doing so.
• In perfect competition, each firm faces a horizontal demand curve.

  • This means the firm can sell as much as it wants at the market price but cannot charge more. If it tries to charge even a little more than the market price, it will lose all of its customers to competitors since the products are identical.
  • If it tries to charge less than the market price, it’s unnecessary, because it can already sell all it wants at the market price.
  • Why horizontal? It is perfectly elastic because the firm is a price taker, so the price does not change regardless of how much output it sells.
• Price Equals Marginal Revenue:

  • Marginal revenue (MR) is the extra revenue the firm gets from selling one more unit of output. In perfect competition, every additional unit is sold at the market price P0P_0P0​, so the price and marginal revenue are the same.
  • MR = P in perfect competition.
• Profit Maximization Rule: MR = MC:

  • The firm maximizes its profit (or minimizes its losses) by producing the quantity where marginal cost (MC) equals marginal revenue (MR).
  • Since MR = P in perfect competition, this means the firm maximizes profit where MC = P.
• Many Firms and Price Taking: Firms cannot influence the market price. They simply accept it and decide how much to produce based on that price.
• Homogeneous Products: All products are identical, so consumers are indifferent about which firm they buy from, as long as the price is the same.
• Horizontal Demand Curve: The firm faces a perfectly elastic demand curve, meaning it can sell any quantity of its output at the market price but cannot charge a higher price.
• 1. Profit Maximization: Firms will continue to produce output as long as the price equals marginal cost. Profit is maximized when the cost of producing one more unit (MC) equals the price the firm gets for that unit (P).
• In the long run, because firms can enter and exit the market freely, the following occurs:

  • If firms in the market are making economic profits, new firms will enter the market. This increases supply, which drives down the price until profits are zero.
  • If firms are making losses, some firms will exit the market, reducing supply, which drives up the price until the remaining firms break even (earn zero economic profit).
• In the long run, firms in a perfectly competitive market will earn zero economic profit. This means they cover all their costs, including opportunity costs, but do not earn excess profits.
• • In perfect competition, firms are price takers and cannot influence the market price.
  • The demand curve for an individual firm is horizontal at the market price.
  • The firm maximizes profit by producing where marginal cost equals the market price.
  • In the long run, free entry and exit of firms ensure that all firms earn zero economic profit.