Perfect Competition
Characteristics
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Large number of firms
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Identical / homogenous product
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Free entry and exit
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Price taker (zero market power)
Demand and Revenue Curves
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Perfectly elastic revenue curve (price taker)
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P = MR = AR
Profit Maximization in short run
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At the output level MC = MR, the profit is maximized
Conditions for profit (at profit maximizing level of output)
Profit Maximisation in the Long-Run
Condition in the long run
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In the long run, all the firm’s resources are variable.
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The number of firms is no longer unchanging, firms could enter or exit the industry
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Firms could only earn normal profit
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Initially the firm is making an economic profit of (a-b) * P1. In the long run, since all of the resources are variable, the profits made by the firm attract new firms to enter the industry. This leads to an increase in supply in the industry, shifting the supply curve from S1 to S2, forming a new equilibrium price P2. Therefore, with the new price P2 the firm is now producing a normal profit.
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Initially the firm is making a loss of (a-b) * P1. In the long run, since all of the resources are variable, the loss made by the firms make the firms leave the industry. This leads to a decrease in supply in the industry, shifting the supply curve from S1 to S2, forming a new equilibrium price P2. There, with the new price P2 the firm is now producing a normal profit.
Allocative Efficiency
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Occurs when firms produce the particular combination of goods and services that the consumers mostly prefer
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Achieved when P = MC (Since P = D = MB, so it is actually MB = MC)
Productive Efficiency
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Occurs when production take place at the lowest possible cost
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Achieved when P = Minimum ATC
*In the long Run of perfect competition, both allocative efficiency and productive efficiency are achieved