A Perfectly Competitive Market is a market structure defined by the following assumptions:
there are a large number of firms
the firms produce homogeneous goods
firms are price takers; they produce at the profit max condition of MC=MR
there is perfect knowledge and information between both producers and consumers
there are no barriers to entry
Each individual firm is a price taker, merely setting price according to the horizontal demand curve, thus the only decision they face is how much to produce. Because perfectly competitive firms operate at the profit max condition, they produce at the intersection of MC and the demand curve. This can result in Normal profit, abnormal profit, and loss.
In the long run, a perfectly competitive market always achieves normal profit. If a perfectly competitive firm develops an innovative product or unique service, it is possible that in the short run they will achieve abnormal profit; however, this abnormal profit attracts other firms to enter the market (remember, perfect information and no barriers to entry), increasing supply and lowering price, and so long run equilibrium is achieved.
The same is true for when a firm is taking a loss. The loss causes firms to leave the market, decreasing the supply and increasing the price
Break-even price: P=AC
Shut-down price: P=AVC
Productive efficiency is achieved when goods are produced at the lowest possible cost per unit, or when average cost is minimized.
Allocative efficiency occurs when the marginal revenue is equal to marginal cost, therefore no resources are wasted in the production of goods. It occurs when firms operate at the profit max condition
Monopolistically Competitive Markets
Monopolistically Competitive Markets are similar to PCMs as they share the characteristics of a large number of firms, no barriers to entry, firms operate at profit max, and both producers and consumers have perfect knowledge. The fundamental difference then, is that MCM's differentiate their products. MCMs advertise significantly in order to differentiate their products from other firms in the market and this gives them more market power and thus, monopolistically competitive firms are not price-takers like perfectly competitive firms.
MCM behave similarly to PCM in that if a firm achieves supernormal profits in the short run, other firms will follow as there are little to no barriers to entry. However, because products are differentiated, the demand curve is downward sloping. Thus, the key issue in a MCM is how substitutable a good is. The more substitutable a good is, the more elastic the demand for that good; the more differentiated the product is, the more inelastic demand is. This is evident in the diagrams above as since the firm does not alter the slope of the demand curve significantly, they cannot maintain their supernormal profits. Because there are no barrieres to entry, firms will be always trying to copy the success of the product achieving supernormal profit. If the firm does not differentiate the product, this will result in a more elastic demand curve, a large supply of goods, and a loss as the goods are all substitutable. For this reason, MC firms use their abnormal profits to advertise and attempt to "stay ahead" of their competitors so to speak.
A Perfectly Competitive Market is a market structure defined by the following assumptions:
Each individual firm is a price taker, merely setting price according to the horizontal demand curve, thus the only decision they face is how much to produce. Because perfectly competitive firms operate at the profit max condition, they produce at the intersection of MC and the demand curve. This can result in Normal profit, abnormal profit, and loss.
Break-even price: P=AC
Shut-down price: P=AVC
Productive efficiency is achieved when goods are produced at the lowest possible cost per unit, or when average cost is minimized.
Allocative efficiency occurs when the marginal revenue is equal to marginal cost, therefore no resources are wasted in the production of goods. It occurs when firms operate at the profit max condition
Monopolistically Competitive Markets
Monopolistically Competitive Markets are similar to PCMs as they share the characteristics of a large number of firms, no barriers to entry, firms operate at profit max, and both producers and consumers have perfect knowledge. The fundamental difference then, is that MCM's differentiate their products. MCMs advertise significantly in order to differentiate their products from other firms in the market and this gives them more market power and thus, monopolistically competitive firms are not price-takers like perfectly competitive firms.
MCM behave similarly to PCM in that if a firm achieves supernormal profits in the short run, other firms will follow as there are little to no barriers to entry. However, because products are differentiated, the demand curve is downward sloping. Thus, the key issue in a MCM is how substitutable a good is. The more substitutable a good is, the more elastic the demand for that good; the more differentiated the product is, the more inelastic demand is. This is evident in the diagrams above as since the firm does not alter the slope of the demand curve significantly, they cannot maintain their supernormal profits. Because there are no barrieres to entry, firms will be always trying to copy the success of the product achieving supernormal profit. If the firm does not differentiate the product, this will result in a more elastic demand curve, a large supply of goods, and a loss as the goods are all substitutable. For this reason, MC firms use their abnormal profits to advertise and attempt to "stay ahead" of their competitors so to speak.