Perfect Competition

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Market demand & supply determine demand faced by the perfectly competitive firm

Diagram Explanation:

Perfect competition = many firms, sells identical products, no barriers of entry

Many buyers and sellers exist -> each firm produces only a very small proportion of total market output -> individual firms cannot influence market supply -> market demand and market supply determine the equilibrium price Pe -> each firm must accept this market price -> the firm is a price taker -> perfectly elastic demand curve as every unit is sold at the same market price

Mkt determines equilibrium price P1 -> individual firm is a price taker -> firms face a horizontal demand curve where P=AR=MR=D -> firms chooses output where MC=MR -> profit maximizing output is at Q1

At Q1 firm sells every unit at P1 -> average cost at this output is AC1
-> P1 > AC1 -> revenue earned on each unit exceeds the cost of producing each unit -> firm earns abnormal profit per unit (represented by shaded area = Q1 × (P1-AC1)

Diagram Explanation:

Mkt determines equilibrium price P1 -> individual firm is a price taker -> firms face a horizontal demand curve where P=AR=MR=D -> firms chooses output where MC=MR -> profit maximizing output is at Q2

At Q2 firm sells every unit at P2 -> average cost at this output is AC2
-> P2 = AC2 -> revenue earned on each unit equals to the cost of producing each unit -> firm earns normal profit per unit

Diagram Explanation:

Mkt determines equilibrium price P1 -> individual firm is a price taker -> firms face a horizontal demand curve where P=AR=MR=D -> firms chooses output where MC=MR -> profit maximizing output is at Q1

At Q3 firm sells every unit at P3 -> average cost at this output is AC3
-> P3c < AC3 -> revenue earned on each unit is less than the cost of producing each unit -> firm lose profit per unit (represented by shaded area = Q3 × (AC3-P3)

Diagram Explanation:

SR abnormal profits exists -> new firms enter bc there are no barriers to entry & seeks for profits -> market supply increases -> market price falls until only normal profit is earned -> In the LR, P = minimum ATC and P = MC
In the mkt, demand = MB and supply = MC -> equilibrium occurs where MB = MC at Qe -> value consumers place on the last unit equals the cost of producing it -> consumer and producer surplus are maximized -> no deadweight loss -> resources are allocated efficiently

Diagram Explanation: