Perfect Competition

1
Perfect Competition

• Outline
• Competition and socially efficient resource
  allocation
• Structural features of competitive markets
• The supply curve of the competitive firm
• Consumer and producer surplus
• The market for daycare

2
Socially Optimal Resource Allocation
To say that the scheme of resource allocation is
socially optimal means that a re-allocation of
resources could not make any one person better
off without making at least one other person
worse off.
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We can trust market forces to allocate
resources in a socially optimal waythat is, if
markets are competitive in structure.
If markets are imperfectly competitive in
structure, then all bets are off.
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Structural features ofcompetitive markets

1. Large number of buyers and sellers
2. No barriers to entry
3. Homogeneous or standardized product
4. Buyers and sellers are price takers.

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Short run supply curve for the competitive firm
The supply curve for the firm is given by MC
above the minimum of AVC.
MC
ATC
Cost per unit
AVC
Output (Thousands of Units)
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Demand curve facing the competitive firm
Revenue per unit
Competitive firm faces an infinitely elastic
demand curve at the market determined price
6
P AR MR
Output (Thousands of Units)
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Competitive firm can earn an economic profit in
short run
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S1
Price
S2
8.00
The opportunity to earn an economic profit
attracts new firms to the market
6.50
D
Quantity
Entry shifts the market supply curve to the right
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Economic profits eroded by entry
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Effect of a change in demand before and after
entry
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The Invisible Hand
According to Adam Smith1, even self-centered
people like me are led by the invisible hand of
competition to promote the best interests of
society.
1Adam Smith. The Wealth of Nations, 1776
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What assumptions must one make about the
structure of markets to prove that the market
system produces socially efficient resource
allocation? Modern welfare economics has this all
worked out.
13
Why competitive markets are efficient
Competitive markets provide efficient amounts
of goods and services at minimum cost to the
consumers who are most willing (and able) to pay
for them.
Samuelson and Marks (1999, p. 330).
14
Consumer and Producer Surplus

• Consumer surplus (CS) is the difference between
  the maximum amount the consumer is willing to pay
  for a given quantity of a good or service rather
  than go without it and what they actually pay for
  a given quantity of the good or service.
• Producer surplus (PS) is the difference between
  the minimum price a seller would have to get to
  offer a given quantity of goods and services and
  the price the seller actually gets for that
  quantity.

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Youre paying 2.69 for a gallon of gasbut I bet
you would be willing to pay more rather than go
without it. If so, there you derive a surplus on
the transaction.
16
Example The Demand and Supply of Day Care

• The Palmers are willing to pay a maximum of 8
  per hour for daycare (10 hours per day) for their
  two year old.
• A grandmother in the neighborhood is willing to
  provide the service. Her minimum acceptable fee
  is 4 per hour.

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Daycare transaction
If the negotiated price is 6, then each party
gets a surplus of 20 per week
18
The Regional Market for Daycare
Blue shaded area shows consumer surplus accruing
to all consumers in the market for daycare
services if P 4 per hr.
19
Figure 8.7 A Competitive Daycare Market
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