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1.2.1: Perfect Competition: Definition

Course video 9 of 77

In the first part of the course we learnt that if we allow market forces to work we reach an efficient outcome: the maximum benefit that can be generated by a market. The second part of the course explores cases where the markets fail to accomplish our goals. This week sets up the benchmark case of the perfectly competitive market: a model we will modify in the next few weeks. We define Perfect Competition, learn to model it graphically and discuss some key results in terms of long run profits and implications for efficiency.

Microeconomics: When Markets Fail

Пенсильванский университет

Perfect markets achieve efficiency: maximizing total surplus generated. But real markets are imperfect. In this course we will explore a set of market imperfections to understand why they fail and to explore possible remedies including as antitrust policy, regulation, government intervention. Examples are taken from everyday life, from goods and services that we all purchase and use. We will apply the theory to current events and policy debates through weekly exercises. These will empower you to be an educated, critical thinker who can understand, analyze and evaluate market outcomes.

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Получаемые навыки

Externality, Economics, Microeconomics, Market (Economics)

Преподаватели

Rebecca Stein
Senior Lecturer

Текст видео

[MUSIC].

In the next few lessons we will look at different market structure in order to

analyze firm's decisions.

I would like to start with benchmark case,

which is the case of a perfectly competitive firm.

So, let me start by defining a perfectly competitive firm.

The perfectly competitive firm has four characteristics.

The perfectly competitive firm produces a standardized product.

It produces in an industry where there are many buyers and sellers.

In this industry there are no barriers to entry and there are no barriers to exit.

And it's an industry that is characterized by full information.

Let me spend a moment on each one of these definitions.

A standardized product means that the firm is producing

a good that many other firms are producing as well.

In other words, my good is very similar to the other firm's good,

and the next firm's good, and the next firm's good.

A good example to think about is some sort of a fruit or a vegetable.

Maybe I'm growing onions, but so is the farmer down the road, and so

is the farmer two villages away.

And onions are onions and onions, and there's not much difference between them.

Another good example to think about is something like a commodity,

something that's used in order to produce something else.

So you can think for example of gasoline.

One unit of gasoline well defined is very similar to the next unit of gasoline.

So again these are the type of goods that we're going to think about.

This is what I mean by a standardized product.

Let me give you an example of what isn't a standardized product,

maybe that's an iPhone.

An iPhone there are substitutes to an iPhone for

example you could have a Galaxy phone or you can have a flip phone.

They produce or they provide some very similar characteristics but

it's definitely not a perfect substitute,

there's only one firm that produces the iPhone and that's Apple.

Let's go to the second step or

the second part of this definition, many buyers and sellers.

So again farming is a good example.

There are many, many farmers who produce onions.

Gasoline is a good example.

There are many, many oil rigs that extract gasoline.

iPhones, not a good example, there's only one phone that produces iPhones.

The third part of the definition no barriers to entry or exit.

That means new firms can enter the market and

firms that don't like the market can easily leave.

Again, farming might be a good example.

It's relatively easy for a farmer to say, well this year I don't want to

grow onions, I want to exit the industry and produce something else.

And on the other hand, it's very easy for new farmers to enter the industry.

I for example can decide one year instead of

growing my usual tomatoes to grow onions, and sell them in the market.

So then no barriers for new firms to enter the market.

Again we can think of industries where that is not the case.

For example suppose I want to start making iPhones, well I can't do that.

First of all I don't have the technology but even if I did it would be illegal for

me to sell a phone and call it an iPhone, only Apple's allowed to do that.

And the fourth assumption that we have here, is that there's full information.

And by full information what I want is for

all the consumers to know what the product is.

What are the true characteristics of the product and

to know what the going price is?

Consumers know this, and firms know this.

So there's full information in terms of what is the product

that we're talking about, and what is the going price in the market?

An important result of our definition of perfectly competitive markets

is that the individual firm has very little market power.

They can't set the price, rather they are going to be price takers.

Why is this the case.

Each individual firm is very small.

There are many firms in the market, all producing an identical product.

Suppose I am a farmer producing onions.

If I raise the price of onions, no one's going to buy the onions from me.

They will go to my competitors that are selling onions at a cheaper price.

On the other hand since I'm such a small farmer there's no point in me lowering

the price as it is I can sell all the product that I have at the going price.

So there's no advantage to lowering the price.

So I'm not going to raise the price,

I'm not going to lower the price I'm going to react to the price in the market.

I will be a price taker.

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