Perfect Competition

PRESENTED BY:
HUZAIFA RASHID(01-111232-106) HASSAN MEHDI(01-111232-099)
SHEHRYAR HAYAT KHAN(01-111232-233) HAMAD JAMIL(01-111232-084)
OMAIR ZAHID(01-111232-295)
What is Perfect Competition?

 Large no. of buyers and sellers

 The Law of
homogeneous products: consumers regard them as identical
One Price
 buyers and sellers have perfect information about prices

 buyers and sellers too large to influence product price Price Takers
 Free entry and free exit of firms
 Perfect competition provides both allocative efficiency and productive
efficiency
What is productive and allocative
efficiency
Productive Efficiency
 Productive efficiency is a situation where
firms seek the best combination of inputs
to lower their costs of production.
Allocative Efficiency
 Allocative efficiency means that
economic resources are distributed in a
way that produces the highest consumer
satisfaction relative to the cost of inputs.
Pricings in perfectly competitive
markets in short run
 In perfect competition, any profit-maximizing producer faces a market price equal
to its marginal cost (P = MC).

 Firm just covers their costs and earns normal profit or zero profit.
 To maximize profit, the firm sets the level of output where marginal revenue
equals marginal cost.
Long run returns in perfectly
competitive markets
 In the long run, profits and losses are eliminated because an infinite number of
firms are producing infinitely divisible, homogeneous products. The only profits
that firms do make in the long run are normal profits. Normal profits occur when
the firms are just covering their costs to remain in the market.
Profits, Losses, and Perfectly Competitive
Firm Decisions in the Long and Short Run
SHORT-RUN SHORT-RUN LONG-RUN
CONDITION DECISION DECISION
Profits TR > TC P = MC: operate Expand: new firms
enter
Losses 1. With operating profit P = MC: operate Contract: firms exit
(TR  TVC) (losses < fixed costs)
2. With operating losses Shut down: Contract: firms exit
(TR < TVC) losses = fixed costs

 In the short-run, firms have to decide how much to produce in the current scale of
plant.
 In the long-run, firms have to choose among many potential scales of plant.
Characteristics of Perfect Competition

i. A Large and Homogeneous Market:

 There are a large number of buyers and sellers in a perfectly competitive market.
 They sell products with minimal differences in capabilities, features, and pricing.
 A large population of both buyers and sellers ensures that supply and demand remain constant in this
market.
 Buyers can easily substitute products made by one firm for another.

ii. Perfect Information Availability:

 The buyers fully understand the quality of the product and the availability of a substitute at the same
price.
 The market creates room for new firms to join as the knowledge of the production process is readily
available.

iv. No barriers to entry

v. Equality of market share
III. No barriers to entry:
 There are no barriers to prevent a new firm from entering the market in perfect competition.
 The cost of production is minimal, the technical knowledge needed for production is readily
available and there are no large firms dominating the market helping new firms to easily be seller of
the market

iv. Equality of market share:

 In perfect competition, all producing firms have an equal market share.
 Reason for this is that the selling price barely exceeds the cost of production.

v. Absence of Controls:
 There are no controls or restrictions over the supply or pricing.
 There is a single uniform price for all products and services in a perfectly competitive market.
Pros and Cons of Perfect Competition

Pros Cons

Provides a convenient framework for The perfect competition model does not
modeling market activity. always reflect real-world market conditions.
Demonstrates how producers are incentivized The model does not account for geographical
to provide lower prices. differences or variations between products.
The model does not account for how
producers benefit from economies of scale.
Do Firms Profit in Perfect Competition?

 Profits may be possible for brief periods in perfectly competitive markets

 the market’s dynamics cancel out the effects of positive or negative profits and
bring them toward an equilibrium.