Week 6

• Perfect Competition

  • Assumptions:

  1. Market has many buyers and sellers
  2. Homogenous good, all firms produce identical products
  3. Firms are price takers (identical goods = not one firms has power to determine price)
  4. No barriers to entry or exit
  5. Perfect information and low transaction cost
  6. Benchmark of efficiency
• Perfect Competition (Short Run)


  Amount of capital employed (also number of firms) is fixed
• Revenues

  • Total Revenue = Price x Quantity Sold (TR = pq)
  • Average Revenue = Total Revenue/Quantity Sold = Price (AR = TR/q = p)
  • Marginal revenue is the additional revenue from selling one additional unit of output
  • Marginal revenue: rate of change of total revenue with respect to quantity sold
  • MR = dTR/dq
• Profit Maximisation


  Occurs where marginal cost cuts marginal revenue from below (units of output adds more to revenue than cost)
• Short Run Shut Down Condition 


  In short run, firm may continue production even if making a loss as long as variable costs are covered. Has effect of minimising losses
• Long Run Competitive Equilibrium

  • Free entry: ability of firm to enter industry without encountering legal or technical barrier
  • In long run, all factors of production are variable; firms may enter (attracted by supernormal profits) or leave (owing to losses) the industry
  • Long run competitive equilibrium occurs at the point where the market price is equal to minimum average total cost
  • At equilibrium, firms earn zero economic profit (considering opportunity cost)
• Equilibrium Under Perfect Competition: Long Run

  • Existence of supernormal profit attracts new entrants to the industry, supply (at industry level) increases, pushing price down and shifting demand curve till supernormal profits are no longer made, no incentive for further new entry, long run equilibrium.
  • Each firm produces output at minimum average cost = allocative efficiency