Perfect

Competition
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Pure or Perfect Competition…

Pure or perfect competition is rare

in the real world, but the model is
important because it helps analyze
industries with characteristics
similar to pure competition.
Characteristics…

1. Many sellers: there are enough so that a

single seller’s decision has no impact on
market price.
2. Homogenous or standardized products:
each seller’s product is identical to its
competitors’.
3. Firms are price takers: individual firms
must accept the market price and can
exert no influence on price.
4. Free entry and exit: no significant barriers
prevent firms from entering or leaving the
industry.
Perfectly Elastic Demand Curve…

The individual firm will view its

demand as perfectly elastic. A perfectly
elastic demand curve is a horizontal
line at the price. The demand curve for
the industry is not perfectly elastic, it
only appears that way to the individual
firms, since they must take the market
price no matter what quantity they
produce. Therefore, the firm’s demand
curve is a horizontal line at the market
price.
Demand Curve of the Firm & Industry

FIRM INDUSTRY
 Perfect competition

Short-run equilibrium
of firm and industry
(profit maximising)
 Short-run equilibrium of industry and firm under
perfect competition

P £
S MC AC

D = AR
Pe AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Perfect competition

Optimum position for

a loss-making firm
 Loss minimising under perfect competition

P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Short-run shut-down point

P £
S MC AC

AVC

D2 = AR2
P2 AR2
= MR2
D2
O O

Q (millions) Q (thousands)

(a) Industry (b) Firm

 Perfect competition

Short-run supply
curve of the firm
 Deriving the short-run supply curve

P S £
MC = S
a D1 = MR1
P1
b D2 = MR2
P2
c D3 = MR3
P3
D1
D2
D3
O O
Q (millions) Q (thousands)

(a) Industry (b) Firm

Perfect competition

The industry
supply curve
 Deriving the industry short-run supply curve

P S £
S
a D1 = MR1
P1
b D2 = MR2
P2
c D3 = MR3
P3
D1
D2
D3
O O

Q (millions) Q (thousands)

(a) Industry (b) Firm

 Perfect competition

Long-run equilibrium
 Long-run equilibrium under perfect competition
Profits return
Supernormal
New firms enter to normalprofits
P £
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

Long-run equilibrium of the firm under perfect competition
£ (SR)MC
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

O Q
 Perfect competition

Long-run industry
supply curves
Various long-run industry supply curves under perfect competition

P S1 S2
b

a c
Long-run S

D1 D2

O Q
(a) Constant industry costs
Various long-run industry supply curves under perfect competition

P S1 S2

Long-run S
c
a

D2
D1

O Q
(b) Increasing industry costs: external diseconomies of scale
Various long-run industry supply curves under perfect competition

P
S1
b S2

a
c
Long-run S

D2
D1

O Q
(c) Decreasing industry costs: external economies of scale