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Unformatted text preview: Perfect Competition March 22, 2009 The problem of the firm is that of maximizing profits: this problem consists of two parts, choosing the amount to produce and choose how to produce that amount efficiently. We have dealt with the second part, now we need to focus on the first: what is the optimal quantity for the firm? The optimal quantity depends on the market structure the firm is operating in. By market structure we mean all the characteristics of a market that in- fluence the behavior of buyers and sellers when they come together to trade: the characteristics that we are looking for are The number of consumers and the number of sellers The degree of differentiability of the product being traded The presence of barriers to entry and/or exit. According to these characteristics we can distinguish among: Perfect Com- petition, Monopoly, Monopolistic Competition, Oligopoly. 1 Perfect Competition Following the categories that we have defined before: Perfect Competition is a market structure with a large number of buyers and sellers, and each buys or sells only a tiny fraction of the total quantity in the market The point is that there are so many agents that nobody can affect the price of the product with his decision of how much to buy or to sell. the product is completely standardized 1 Buyers cannot find significant differences among products of differ- ent firms. So, buyers dont have a particular taste for a specific brand: they are indifferent between any of the firms. sellers can easily enter or exit from the market In real life there are many markets with barriers to entry: they could be legal barriers, or just informal barriers... All these make entry costly, so that potential competitors are discouraged to enter the market. In perfect competition we assume that this doesnt happen. 2 The Demand Curve in Perfect Competition The Demand Curve facing the individual firm in Perfect Competition is Perfectly Elastic, so it is an horizontal line. Why? 1. remember that there are many many firms 2. moreover the product is completely standardized 3. So, if a firm decides to sell at a high price, all its customers will switch to one of the competitors, and the firm will loose everything. 4. Each firm is so small that it cannot influence the market price with its quantity decisions Since the demand facing each firm is horizontal, every quantity sold by the firm will be sold at the same price. It is not possible to sell any unit of product at a different price. In Perfect Competition, the firm is a price taker: it treats the price of its output as given. Notice that even though the Demand facing each individual firm is hori- zontal, the Market Demand is decreasing....
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- Spring '08
- Perfect Competition