Chapter 4 - Competition, Equilibrium, and Efficiency Flashcards
perfectly competitive industry is an industry with…
…no barriers to competition
main features of a competitive industry
- Atomistic firms
- Homogeneous products
- Perfect information
- Free entry
Atomistic firms
= there are many competitors, all small relative to the market and unable to affect the market price through their actions
Homogeneous products
competitors produce exactly the same product (compete head-to-head on price)
Perfect information
Everyone (firms and consumers) knows about prices and product characteristics
Free entry
there are no barrier to establishment of a new firm (other than “normal” entry costs). Imitation is possible: others can enter the business if they wish; and if they do, they incur the same costs as the incumbents do
if a firm has a sustainable competitive advantage, that advantage must lie in…
…the violation of one of the conditions of the perfect competition model
Each firm faces a … demand curve
flat
infinitely elastic demand: the firm can sell all it wants at market price and nothing at a higher price
Profit maximising condition
MC (q) = p
each firm’s supply decision is governed by its marginal cost curve. it supplies the quantity at which marginal cost equals price
industry supply curve
if we put all firms together, we sum their supply at each price, deriving the industry supply curve
S (p) = q1 + q2 + q3 + …
Market equilibrium
the point of intersection between the demand and supply curves
none of the market participants have an incentive to change their behaviour
excess supply
if price is above equilibrium, fewer people want to buy than sell
would drive the price down to equilibrium
excess demand
if price is below equilibrium, fewer people would want to sell than to buy
would drive the price up
law of supply and demand
price tends to move in the direction of the equilibrium price (where supply equals demand)
comparative statics
is used by economists to describe the exercise of looking at what happens to equilibrium if an exogenous factor changes
a rightward shift of the demand curve leads to an increase in quantity and a (1) in price
a rightward shift of the supply curve leads to an increase in quantity and a (2) in price
(1) increase
(2) decrease
the impact on price or quantity depends on the … of the supply and demand curves
slope
for shifts in demand, the impact depends on the slope of the supply curve (and the other way around)
short run
period when the number of firms is fixed
long run
consider the possibility of entry and exit
the short run equilibrium price might be above average cost
firms can make above normal profits in the short run
in the long-run equilibrium under perfect competition firms produce at the minimum average cost and make zero profits
if the price is greater than the average cost, we would expect new firms to enter the industry
market supply shifts to the right, driving down market price
ultimate effect: firm’s profit goes down to zero
if different firms have different cost structures, then in a long run competitive equilibrium, the marginal firm will be one for which p=…
p = MC = AC
rent
any payment in excess of the costs needed to bring that factor into production
firms that have cost advantages will be able to make a positive profit (=rent)
Model of competitive selection
same assumptions as perfect competition except
- firms must pay a sunk cost in order to enter
- not all firms have access to the same technology
