Market Structures, Perfect Competition, Monopoly, and Things Between ‹ 117
9.1 Perfect Competition
Main Topics: Structural Characteristics of Perfect Competition, Demand for the Firm, Profit
Maximization, Short-Run Profit and Loss, Decision to Shut Down, Long-Run Adjustment
Structural Characteristics of Perfect Competition
Each market structure is defined by structural characteristics. These characteristics deter-
mine, among other things, how the profit-maximizing price and quantity are set in the
short run, as well as how profits might be maintained in the long run. Perfect competition
is typically described by four characteristics:
- Many small independent producers and consumers. Each firm is too small to have an
impact on market price. No one firm can drive up the price by restricting supply, or drive
down the price by flooding the market with output. No one consumer can, by changing
the amount of the good that he consumes, impact the price.
- Firms produce a standardized product. There exist no real differences between one firm’s
output and the next.
- No barriers to entry or exit. There exist no significant obstacles to the entry of new firms
into, or the exit of existing firms out of this industry. Profitability or lack thereof deter-
mines whether the industry is expanding or contracting.
- Firms are “price takers.” This characteristic is actually a result of the first three. Because
all firms are too small to affect the price, they must accept the market price and produce
as much as they wish at that price. Even if they couldchange the price, they would not
do so. To see this, suppose that the market determined competitive price of barley is $5.
If farmer Katie increased the price to $5.01, she would now be the high-price supplier
of barley, with thousands of competitors producing an identical product at a lower price;
Katie is likely to lose all of her customers. If she lowers her price to $4.99, she would
seemingly clean up her competition. But, remember, the price-taking characteristic tells
us that Katie can sell all she wants at the market price of $5. If you can sell all you want
at $5, why would Katie sell even one unit at $4.99?
All four of the characteristics of perfect competition are rarely found in today’s industries,
but agricultural commodities are usually regarded as approximately perfectly competitive.
Demand for the Firm
Each perfectly competitive firm produces a standardized, or homogenous, product. Because
each firm’s output is such a small share of the total market supply, the demand for each
firm’s output is perfectly elastic. Perfectly competitive firms have no effect on the market
price; they simply produce as much as they can at the going price. This implies a horizon-
tal demand curve for their product. This does notimply that the market demand curve is
“In order to keep
the different types
of firms straight,
make a table
including the
firm’s definition,
what kind of
product they
produce, barriers,
and how they
control price. It is
the best way to
study.”
—Kristy, AP
Student
KEY IDEA
Figure 9.1
S
D
Qty
d = Pe
The U.S. Barley Market One Barley Producer
Qty
$P $P
Pe Pe
