Perfect Competition- Microeconomics 3.7

Summary

In this video, Jacob Clifford introduces the concept of perfect competition, a key topic in microeconomics. He explains the characteristics of perfectly competitive markets, where many small firms sell identical products and are price takers. The video explores how these markets achieve long-run equilibrium, with firms making no economic profit. Jacob also discusses the importance of understanding perfect competition for mastering other market structures. He highlights key concepts like total revenue, total cost, profit, and efficiency, and provides practical tips for drawing side-by-side graphs to analyze firm behavior in different scenarios.

Takeaways

• 😀 Perfect competition is one of the four main market structures, and it's essential for understanding the other three.
• 😀 In a perfectly competitive market, there are many small firms selling identical products, and these firms are 'price takers'.
• 😀 Perfectly competitive markets have low barriers to entry, allowing new firms to enter if there are profits to be made.
• 😀 Firms in perfect competition produce at the point where marginal cost (MC) equals marginal revenue (MR), which determines their output level.
• 😀 In the short run, firms may make a profit or loss, but in the long run, competition will drive economic profit to zero.
• 😀 In the long run, if firms are making a profit, other firms will enter the market, increasing supply and lowering prices until profits disappear.
• 😀 If firms are making a loss in the short run, some will exit the market, causing supply to decrease, which raises prices and brings the market back to equilibrium.
• 😀 Perfectly competitive firms are both allocatively efficient (price equals marginal cost) and productively efficient (producing at the lowest possible cost).
• 😀 Unlike monopolies, perfect competition avoids deadweight loss because the quantity produced aligns with society's demand.
• 😀 There are two types of cost industries to consider: constant-cost industries, where the price remains the same as firms enter, and increasing-cost industries, where the price rises as more firms enter.

Q & A

What is perfect competition and why is it important in microeconomics?

Perfect competition is a market structure where many small firms sell identical products with low barriers to entry. It is important because it represents an idealized market scenario with maximum efficiency and is the foundation for understanding other market structures.

What are the main characteristics of a perfectly competitive market?

In a perfectly competitive market, there are many small firms, all producing identical products (commodities), and no barriers to entry. Firms are price takers, meaning they accept the market price, and there is free entry and exit from the market.

What does 'price taker' mean in the context of perfect competition?

A price taker is a firm that has no control over the market price and must accept the price set by supply and demand forces. In perfect competition, firms are price takers because they sell identical products, and consumers can easily switch between firms.

How do firms in perfect competition determine their profit or loss in the short run?

Firms in perfect competition calculate their profit or loss by comparing total revenue (price × quantity) to total cost (average total cost × quantity). If total revenue exceeds total cost, the firm makes a profit; if total cost exceeds total revenue, the firm incurs a loss.

What happens in the long run if firms in perfect competition are making profits?

If firms are making profits in the short run, new firms will enter the market, increasing supply and driving the market price down. In the long run, this results in firms making zero economic profit, as the market reaches long-run equilibrium.

What is long-run equilibrium in a perfectly competitive market?

Long-run equilibrium occurs when firms in a perfectly competitive market are making zero economic profit, meaning total revenue covers all explicit and implicit costs. In this state, no firm has an incentive to enter or exit the market.

What is the concept of allocative efficiency in perfect competition?

Allocative efficiency in perfect competition occurs when the price of a product equals the marginal cost of producing it. This means that the value consumers place on the last unit produced is exactly equal to the cost of producing that unit, ensuring no deadweight loss.

What is the difference between productive efficiency and allocative efficiency in perfect competition?

Productive efficiency in perfect competition occurs when firms produce at the lowest possible cost (at the minimum of the average total cost curve). Allocative efficiency happens when the price equals the marginal cost, meaning resources are allocated in the most beneficial way for society.

What is the effect of an increase in demand in a perfectly competitive market?

An increase in demand shifts the market demand curve to the right, raising the price in the short run. This leads to firms making profits, which attracts new firms into the market, increasing supply and eventually bringing the price back down to the long-run equilibrium.

What happens in a constant cost industry when new firms enter the market?

In a constant cost industry, when new firms enter the market, the price remains unchanged because the costs of production do not rise with increased supply. This means the market price stays the same even as new firms join the market.