Economics / Unit 5: Market Structures and Competition
5.1 Perfect Competition
Notes
A market structure describes how many firms are in a market and how much they compete. Perfect competition is the most competitive structure.
- Conditions: many buyers and sellers, identical (standardized) products, easy entry and exit, and full information for buyers and sellers.
- Each firm is a price taker: it is too small to affect the market price, so it sells at the price set by market supply and demand. Its marginal revenue equals the market price.
- If a firm charged more than the market price, buyers would go to identical sellers.
- In the long run, profits attract new firms and losses drive firms out, so firms earn only enough to cover all their costs, including the opportunity cost of the owner's time.
- Real markets come close but are rarely perfect. Examples: wheat, corn, and other farm commodities.
- Worked example: wheat sells for $6 per bushel. A farmer who sells 1,000 bushels earns $6 \times 1{,}000 = 6{,}000$ dollars. If she raised her price to $7, buyers would buy identical wheat from other farmers at $6.
Practice
Which market is closest to perfect competition?
Many sellers offer an identical product, so no one can set the price.
A perfectly competitive firm is called a "price taker" because:
Buyers can get an identical product from many other sellers at the market price.
In a perfectly competitive market, firms earn large profits. What will most likely happen in the long run?
Easy entry means profits attract competitors until the extra profit disappears.
Ready for more? Take the Unit 5 test.