Markets in perfect competition general characteristics:
- both buyers and sellers are price takers
- Competition in this case eliminates any bargaining power, so equilibrium is competitive equilibrium, also a Nash equilibrium in this case.
- Equilibrium at D = S, Pareto efficient point as well as no DWL
Pareto efficiency in perfect comp markets depends on 3 assumptions:
- price taking consumers and sellers, so MC = P MR = D
- Complete contract, exchange is governed by legal and refund system
- No external effects on anyone else but buyer and seller
PED in perfect comp
Perfectly elastic as any other price would lead to consumers switching to cheaper competitors.
Why is output at MC = P*
- If MC > P, the last unit would cost more than p to make, so firm would make a loss on this unit and could make higher profits by reducing output.
- If MC < P*, could produce more units, so could make higher profits by raising output
- demand curve = MR curve as for each extra good sold, marginal/ added revenue is p*, so demand curve = MR.
P n Q
- profit maximises
- price taker
P n MC
- MC< P
- MC = P
DWL
- yes
- no
Economic rents
- owners receive economic rent
- rent not LT sustainable
Advertising
- firms advertise unique products
- little advertising
RnD
- firms invest
- Little incentive for innovation as innovation rents dont last
Necessary for perfect competition
- many undifferentiated sellers
- sellers must act independently
- many buyers
- buyers know the sellers’ prices
MC cuts Isoprofit curve at
Each isoprofits lowest point
Firms have no price setting power
So one price for the market P*
2 OUTPUT POINTS
Where MC = MR (P)
OR
Where P = tangent to isoprofit curve
Market supply curve is just
The sum of all the firms’ supply curves
Pareto efficiency of Perfect Competition
Moving from monopolistic to this is not a Pareto improvement and vice versa.
- any increase or decrease of price will not be a Pareto improvement
- so this point is Pareto efficient.
Change in demand would lead to
Every level of price higher q demanded, so there is a movement along the supply curve to new equilibrium.
MC =
MR =
MC = DC/DQ
MR = DTR/DQ
