The Market Structures:

1. Perfect Competition

2. Pure Monopoly

3. Monopolistic Competition

4. Oligopoly

This chapter focuses on Perfect Competition.

Perfect Competition

Perfect Competition is defined as a market where:

1. Perfect information

2. Freedom of entry and exit

3. Numerous buyers and sellers

4. Standardized (homogeneous) product

The profit maximizing rule, MR=MC, together with thefact of flat demand (implying P=MR) imply that theprofit maximizing output under perfect competition willbe where P=MC.

Since profit is R- C, it can also be written as P*Q-AC*Qor (P-AC)Q. Notice that (P-AC)=DE in the drawing, andthat Q*=EC in the drawing. Therefore the profit is thearea of the rectangle and is the product, DE*EC.

Short Run Profits Under Perfect Competition

The “tra g e d y” o f whe a tfa rm ing c o uld ha p p e nto yo ur inte rne t c o m p a ny.

Q

PS

D

P E

To sta rt: Sup p o se the whe a tfa rm e rs a re m a king a p ro fita t the m a rke t e q uilb rium , P .E

Q

PS

D

PE

Sne w

The p ro fita b ility o f whe a t fa rm ing a ttra c ts o the r e n tra n ts in the lo ng run . Eve ntua lly the e c o no m ic p ro fits will b e d rive n d o wn to ze ro .

Q

P

AC

PLRE

P No nEq uil.

.LRE

Ano the r vie w o f the whe a t fa rm e r’sfa te in the lo ng run. Ze ro (ie . “No rm a l” p ro fits).

What markets are like the wheat farming example?

1. Automobiles? 2. Utilities? 3. Dot Coms? 4. Physician care? 5. Gas statitions? 6. Stocks and bonds?

What the theoretical perfect competition does especially well:

Efficiency: Competition ideally results in “Pareto Optimality,” a form of efficiency that takes advantage of every possibility for mutual gain.

That is, you couldn’t make even one person better off without taking from someone else.

That is, perfect competition is good at:

1. Producers are technically efficient. 2. Producers are allocatively efficient. 3. Consumers are also efficient. 4. Even the producers and consumers are coordinated in an efficient way.

That is, it is also good at:

1. Supply equals demand. 2. Society is on the production possibilities frontier, too.

But, what the competitive market society does not guarantee:

1. There may still be poor, sick or hungry families. 2. True talent may not be rewarded. 3. Some market outcomes will undoubtedly seem unjust to many people.

Is it our economy?

Differences between the competitive market assumptions and United States reality:1. Most of our GDP is produced in markets where firms have at least some market power. 2. Information is often imperfect.

3. In some markets, entry and exit isn’t free. 4. Products are often differentiated. 5. There are many public goods and externalities.

For example, prices were “administered.”

For popular goods, such as bread or vodka, prices were kept artificially low to please the population.

The Soviet model was a “command economy.”

Thus, an important difference between a command system (e.g. USSR) and a market system (e.g. US) is is that market systems allow the markets to reach their equilibrium.

Soviet leaders feared the U.S. power and distrusted our intentions. The result was much economic capital sunk into the arms races.

And, the space race.

Another importance difference is that market systems provide individuals with incentives to provide market goods efficiently.

And, markets generate a great deal of information that central planners cannot possibly have at hand.

And, market systems learn by trial and error.And, market systems respect individual wants.