Lecture 12: Perfect Competition (II)
Suggested questions and exercises (Pindyck and Rubinfeld, Ch.8).
Questions: 6, 7, 9
Exercises: 10, 12, 13
At the beginning of the twentieth century, there were many small American
At the end of the century, there are only three large
Suppose that this situation is not the result of lax federal enforcement of
(Hint: What is the inherent cost structure of the automobile
Automobile plants are highly capital-intensive.
Assuming there have been no
impediments to competition, increasing returns to scale can reduce the number
of firms in the long run.
As firms grow, their costs decrease with increasing
returns to scale.
Larger firms are able to sell their product for a lower price and
push out smaller firms in the long run.
Increasing returns may cease at some
level of output, leaving more than one firm in the industry.
Industry X is characterized by perfect competition, so every firm in the industry is
earning zero economic profit.
If the product price falls, no firms can survive.
agree or disagree?
As the market price falls, firms cut their production.
If price falls
below average total cost, firms continue to produce in the short run and cease
production in the long run.
If price falls below average variable costs, firms
cease production in the short run.
Therefore, with a small decrease in price, i.e.,
less than the difference between the price and average variable cost, the firm
With larger price decrease,
i.e., greater than the difference
between price and minimum average cost, the firm cannot survive.
we would expect that some firms will survive and that just enough firms will
leave to bring profit back up to zero.
Why does a tax create a deadweight loss?
What determines the size of this loss?
A tax creates deadweight loss by artificially increasing price above the free