Main content

AP®︎/College Microeconomics

  • Introduction to perfect competition
  • Economic profit for firms in perfectly competitive markets
  • Perfect competition foundational concepts
  • Long-run economic profit for perfectly competitive firms
  • Long-run supply curve in constant cost perfectly competitive markets
  • Long run supply when industry costs aren’t constant
  • Free response question (FRQ) on perfect competition
  • Perfect competition in the short run and long run
  • Increasing, decreasing, and constant cost industries
  • Efficiency and perfect competition

Introduction to perfect competition

Perfect competition is a theoretical market structure in which there are many buyers and sellers, identical products (also called homogeneous products), perfect information, and no barriers to entry.

Want to join the conversation?

  • Why is MR=D? It makes no sense to have a D curve with a constant price, as it is supposed to reflect a change in Qd based on the change in price…(3 votes)
  • Is marginal revenue and market price same in perfect competition? and why marginal revenue is taken as demand curve and average revenue?(2 votes)
  • What does ATC stand for and why is it used when Sal is talking about Marginal Revenue?(0 votes)
    • ATC = Average Total Cost. In a perfectly competitive market, the long run equilibrium is where MR=MC=the minimum of ATC(1 vote)

Video transcript

– [Instructor] In our study of the different types of markets, we are now going to dive a little bit deeper and understand perfect competition. Now this notion of something being perfectly competitive, you might have a general idea of what it means. You might feel like it’s very competitive, that there’s a lot of people there maybe competing for your business, or maybe there’s a lotta buyers, and there are a lotta sellers. And that is generally true, but we’re trying to be economists here, so we wanna be very precise with our language. So when economists talk about perfect competition, they’re talking about this somewhat very abstract state where you have many buyers and sellers, many sellers and buyers. Now that doesn’t seem too abstract so far. We can imagine a lot of markets that have many sellers and buyers. Now another thing that defines perfect competition from an economics point of view is that they’re selling identical, identical products or services, products, products or services. Now this one seems a little bit harder because even when you can imagine a fairly competitive market, does everyone sell exactly the same thing? Well you imagine certain markets, maybe the market for water or maybe the market for some type of energy or maybe the market for produce, gets pretty close to identical products or services. So so far it doesn’t seem like that abstract of a thing. Now another aspect of perfect competition is that every agent, so that would be the buyers, the sellers, the producers, the consumers, they have perfect information, perfect information. Now what does perfect information mean? It means that every participant in the market, the buyers and the sellers, they all know exactly what is happening in the market. So what goods or services are selling for what price and who is selling to whom. So once again, this gets a little bit more abstract because to get truly perfect information, you can’t, not everyone in a market will always know everything that’s going on. So once again, this is a little bit of an abstract idea that economists have introduced to be a little bit more precise. And the last aspect we’re going to talk about, and this is also something that is a bit idealized that doesn’t truly exist in the real world, things close to this exist in the real world, is that there is no barriers, barriers to entry or exit. Now we already mentioned some markets, say the market for agriculture. That doesn’t quite have no barriers to entry or exit. You would somehow have to get land, you would have to get seeds, you would have to get fertilizer, you would have to hire people to put the seeds in and to harvest the crops. And so almost any industry, any market you imagine, will have some barriers, but this is an idealized notion that economists like to think about, and of course in the real world things might approach this or be closer to perfect competition than say other markets. But when you’re in this situation, let’s analyze what will be happening. So we can look at the market as a whole for whatever this product and service is. So let me draw price versus quantity here for the market as a whole. So this is price, and this is quantity. And this is the market right over here. And so, we’ve seen this multiple times in our economics journey. That you have an upward-sloping supply curve, and once again this is for the entire market. Let me do this is in a different color. So you have an upward-sloping supply curve like that. And you would have a downward-sloping demand curve like that. And we know what the equilibrium price and quantity would be for the market. So this right over here would be the equilibrium, equilibrium quantity for the market, and this right over here would be the equilibrium price for the market. Now how would this affect the decisions for the firm in perfect competition? Well let’s draw, let’s draw a similar analysis, but now at the firm level. So on this axis, you could view this for the firm, and so this is going to be the firm right over here, one of the participants in the perfect competition, one of the producers, one of the sellers. So on this axis, you could view this as price. You could also view this as marginal revenue. And you could also view this as marginal cost because we’re going to plot the different curves here. And then on the horizontal axis, we’re going to have quantity again, but this is once again the quantity that the firm produces. Now, first of all, we could think about the marginal cost for the firm, and we’ve seen this multiple times. That the marginal cost for the firm, it might look something like this. It over time might trend upwards something like this where at some point every incremental unit is costing more and more to produce. Maybe it’s harder to get the resources, harder to get the labor, whatever you wanna say. So that’s the marginal cost curve, fairly typical for a firm. And then we could think about their average total cost. And so the average total cost curve might look something like this. So draw something like this. So our average total cost, we’ve seen this multiple times. Now what is going to be the marginal revenue for this firm that is operating in perfect competition? Well when it’s operating in perfect competition, it just has to be a price taker. So every unit it sells is just going to get the market price for that unit. So in perfect competition, the firm, every participant that is really identical in a lotta ways, they’re just gonna take that price. Think about it, they won’t be able to charge any more for their product or service than the market price because their product or service is identical to everyone else’s, and everyone knows it because of perfect information, and they would have no motivation to charge less either. They’re just passive. You could view it that way when it comes to price. So if we just take this market price across just like that. This right over here, this price, is going to define the marginal revenue curve for that firm. So let me make this a bold curve right over here. This is going to be the marginal revenue for the firm. For every unit it sells on the margin, that’s how much more revenue it’s going to get. Now you could also view this as the demand curve for the firm’s product. You could also view this as the average revenue for the firm’s product. And let me make this clear, this is for the firm, demand for the firm, which is equal to the price that the firm actually gets. So the big takeaway here is in perfect competition, which is this somewhat idealized state that doesn’t quite exist in the real world, certain markets can approach it, the firms are passive price takers. They have no say on what the price is going to be, and so it would be rational for them to just produce where their marginal cost intersects with their marginal revenue. Because anything more than that, then for every incremental unit, they’re going to be spending more money than they get in terms of revenue. And this passivity goes a little bit against some of our everyday notions of fierce competition. When we think about fierce competition, we often think about many players trying to constantly undercut each other, and in future videos, we’ll talk about scenarios where that might happen. And you might think about whether or not you would want certain markets to have perfect competition. Because no barriers to entry means that frankly anybody could get into that industry. So for example, you might not want perfect competition when it comes to someone being say your doctor because you want barriers to entry. You want some level of training. You want some level of experience before someone gets into that service.

You are watching: Introduction to perfect competition (video). Info created by GBee English Center selection and synthesis along with other related topics.