Econ251a-2006
PERFECT COMPETITION: A FIRST LOOK
Perfectly competitive equilibrium arises when certain pre-conditions are satis
f
ed.
It is a paradoxical situation, in which every agent is haggling as hard as he can over
the price, and yet the result is as if nobody had any control over the price whatsoever.
The basic implications of the hypothesis that the economy is in perfectly competitive
equilibrium are also paradoxical. For example, it follows that it does not matter
whether a tax is put on the buyers or the sellers. Yet the theory has been con
f
rmed
by overwhelming empirical data.
The
preconditions for perfect competition
include a large number of both buyers
and sellers of a homogeneous good, for which the property rights at the outset are
well-de
f
ned, and such that each agent’s valuation of the good is self-generated and
does not depend on what the other agents think. The
theory of perfect competition
holds that when these preconditions are satis
f
ed, and the agents are free to engage in
voluntary and public trades of the commodity for money, then the trades will almost
all take place at the same “competitive price,” namely that price
P
such that if all
the buyers could purchase whatever amount
D
(
P
)
they wanted at the price
P
,and
if all the sellers could sell all that they wanted,
S
(
P
)
, at the price
P
,thendemand
would equal supply,
D
(
P
)=
S
(
P
)
.
In our football tickets example every buyer and seller was interested in precisely
one ticket, and we associated with each buyer and seller his reservation price, or
valuation, of that one ticket. For a buyer, his valuation was the maximum amount of
money he was willing to pay to get a ticket, and for the seller his valuation was the
minimum amount of money she needed in order to willingly give up her ticket.
Assuming that the number of buyers is very large, we can depict graphically the
situation of the buyers by a continuous, decreasing curve in
Q
−
P
space. We list
the buyers in decreasing order of their valuations on the horizontal axis, and on the
vertical axis we put those valuations. The pair
(
Q, P
)
on this “demand curve” can be
interpreted in two di
f
erent ways. For the quantity
Q
,
P
is the valuation of the
Q
th
buyer, that is
P
is the maximum price at which at least
Q
buyers would purchase a
ticket. Alternatively, we could say that for the price
P
,
Q
is the maximum number
of buyers who would be willing to pay
P
to get a ticket.
Assuming the number of sellers is large, we can depict graphically the situation
of the sellers by a continuous, increasing curve in
Q
−
P
space. We list the sellers in
increasing order of their valuations on the horizontal axis, and on the vertical axis
we put those valuations. Once again the pair
(
Q, P
)
on this ”supply curve” can be
interpreted in two di
f
erent ways. For the quantity
Q
,
P
is the valuation of the
Q
th
seller, that is
P
isthem
in
imumpr
iceatwh