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4 Perfect Competition Ch 8

4 Perfect Competition Ch 8 - Chapter 8 Theory of Perfect...

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4/2/2008 1 Chapter 8 Theory of Perfect Competition Five Assumptions of Perfect Competition 1. Large Numbers No individual demander buys or supplier produces a significant proportion of the total output. No one has enough market power to determine prices. This implies all consumers and firms will be price takers . Price is determined in the market – it is equilibrium market price. 2. Perfect Information All participants have perfect knowledge of all relevant prices and of all relevant technological information.
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4/2/2008 2 3. Product Homogeneity The products of all firms in any given market (industry) are identical. This is one reason we use agricultural producers as examples of perfectly competitive markets. 4. Perfect Mobility of Resources If a firm can freely allocate resources to different uses, they can expand or contract output and enter or exit the industry itself. This results in our first-year assumption of free entry or exit. 5. Independence Preferences of each individual are independent of consumption decisions of others and production decisions of firms. Production functions of all firms are independent of individuals’ consumption decisions and other firms’ production decisions.
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4/2/2008 3 In a market economy, prices are the signals that guide and direct the allocation of goods and resources. In a competitive equilibrium, consumers who value the goods the most get them. Goods are supplied by firms who sell at the least production cost. The competitive equilibrium is Pareto-optimal. Firms’ SR Supply Decision A firm’s profit ( π ) is its total revenue (TR) minus short-run total costs (SRTC). The profit function is expressed as: π (y) = TR(y) - SRTC(y) Since p is given (firms are price takers), firms choose y to maximize profit.
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