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Perfectly Competitive Markets

price taking - firms take market price as given  

  • individual firms sell sufficiently small part of total market output
  • firms can't decide what market price is in a perfectly competitive situation
  • consumers also act as price takers
  • individual decisions do not affect the outcome of the whole

product homogeneity - firms produce nearly identical products  

  • products essentially perfect substitutes for each other >> very elastic
  • commodities - homogeneous materials such as raw metals, oil, gasoline, vegetables, fruit
    • consumers don't really care what specific firm made which
  • name brands (ie. Nike, Adidas, Bluebell) not taken into consideration in perfectly competitive situations
  • helps ensure a single market price

free entry/exit - no costs for new firm to enter/exit industry  

  • lets consumers switch from 1 supplier to another
  • firms can enter if it sees profit, exit if losing profit
  • medical, high-tech firms not perfectly competitive
    • need research, patents, investment (entry costs) to sell in market
  • large number of firms or hight elasticity can lead to high competition

profit maximization - price fixed, so cost needs to be minimized  

  • dominates most decisions w/ small firms
  • larger firm >> owners have less contact w/ managers >> managers have more leeway to act on their own
    • managers may be more focused on short-run than long-run

profit - difference between total revenue and total cost  

  • p(q) = R(q) - C(q)
    • R(q) = Pq
    • profit maximized where difference between revenue and cost is greatest
  • marginal revenue - slope of revenue curve, change in revenue after one-unit increase in output
  • MR(q) = MC(q) = P
    • marginal gain in revenue equals marginal gain in cost at max profit
  • firms in a large market >> face horizontal demand curve
    • market demand still downward sloping, but market is so elastic for each firm (price taker) that individual firms face a different demand curve
    • marginal revenue, average revenue, price all equal on demand curve for individual firms
  • output rule - if firm produces anything, it should produce at the level where marginal revenue equals marginal cost
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