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Unformatted text preview: Comm 295 8.1-8.3 Perfect Competition 8.1 PERFECT COMPETITION Perfect competition : a market structure in which buyers and sellers are price takers; industry is highly competitive PRICE TAKING AND HORIZONTAL FIRM DEMAND CURVES- All firms and buyers are PRICE TAKERS- Firm cannot affect market price for product it sells- Demand curve is horizontal at the market price o Can sell as much as it wants at market price If sell lower, sales wont increase If sell higher, no one will buy CHARACTERISTICS OF PERFECTLY COMPETITIVE MARKETS- 5 characteristics of perfectly competitive markets 1) Large number of buyers and sellers o Large number of makes it so no one can affect market output and price (for both buyers and suppliers) 2) Identical products o Sell identical or homogenous products o Difficult for any single firm to raise its price as selling same product as others 3) Full information o Customers knowing that firms sell same products and of all prices, firm cannot raise price 4) Negligible transaction costs o Buyers and sellers do not have to spend much time and money finding each other to make a trade Easy for customer to buy from a rival firm as transaction costs are low (easy to switch) 5) Free entry and exit o Results in a large number of price taking firms to enter industry o Free entry: keep price at its level if one firm raises price and earns profit, other firms will see this opportunity and enter industry, therefore forcing prices to go down o Free exit: encourages entry as they can easily exit if not making a profit DEVIATIONS FROM PERFECT COMPETITION- Competitive firms or competition refers to the inability of buyers/sellers to affect the market price of a good o Firms may be competitive but do not possess all characteristics of perfect competition 8.2 COMPETITION IN THE SHORT RUN- Assume all firms (not just competitive) want to maximize profits o Especially competitive though if they dont, they lose money and will be driven out of business SHORT-RUN COMPETITIVE PROFIT MAXIMIZATION- 2 steps to maximize profit: o Determine output at which it maximized profit (or minimizes loss) o Decides whether to produce or shut down The Short-Run Output Decision- Max profit at output where marginal profit = 0, or where MR(q) = MC(q)- Because competitive firms have a horizontal demand curve , can sell as many units of output as it wants at the market price, p o Marginal revenue = p o Produce amount of output where market price equals marginal cost p = MC(q)- Where firm produces less than optimum quantity, market price would be above its marginal cost o As a result, firm could increase its profit by expanding output- Where firm produce more than optimum quantity, market price would be below marginal cost Comm 295...
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- Winter '09