Pure Competition

There are many industries. Economist group them into four market models: 1) pure competition which involves a very large number of firms producing a standardized producer. New firms may enter very easily. 2) Pure monopoly is a market structure in which one firm is the sole seller a product or service like a local electric company. Entry of additional firms is blocked so that one firm is the industry. 3) Monopolistic competition is characterized by a relatively large number of sellers producing differentiated product. 4) Oligopoly involves only a few sellers; this fewness means that each firm is affected by the decisions of rival and must take these decisions into account in determining its own price and output. Pure competition assumes that firms and resources are mobile among different kinds of industries.

No single firm can influence market price in a competitive industry; therefore a firm s demand curve is perfectly elastic and price equals marginal revenue. Short-run profit maximization by a competitive firm can be analyzed by comparing total revenue and total cost or applying marginal analysis. A firm maximizes its short-run profit by producing that output at which total revenue exceeds total cost by the greatest amount.

A complete firm maximizes profit or minimizes loss in the short run by producing that output at which price or marginal revenue equals marginal cost, provided price exceeds minimum average variable cost. If price is less than average variable cost, the firm minimizes its loss by shutting down. If price is greater than average variable cost but less than average cost, the firm minimizes its loss by producing the P=MC output. The firm minimizes its economic profit at P=MC output if price exceeds average total cost.

Applying that MR(=P)=MC rule at various possible prices leads to the conclusion that the segment of the firms short-run marginal cost curve lying above its average variable cost curve is its short-run supply curve.

The market price of a product will equal the minimum average total cost of production it its in the long run. At a greater price, economic profits would cause firms to enter the competitive industry until those profits had been competed away. At a lesser price, lesser would force the exit of the firms industry until the product rose to equal average total cost. The long- run supply curve is horizontal for a constant-cost industry, up-sloping for an increasing cost industry. The long-run equality of price and minimum average total cost means that competitive firms will use the most efficient known technology and change the lowest price consistent with their production cost. The long-run equality of price and marginal cost implies that resources will be allocated in accordance with consumer tastes. The competitive price system will reallocate resources in response to a change in consumer tastes, technology, or resource supplies to maintain allocative efficiency over time.

In allocating resources, the competitive model dies not allow for spillover cost and benefits of for public goods. A purely competitive industry may preclude the larger scale production needed for individual firms to achieve economies of scale and therefore obtain the lowest possible per-unit production costs. Pure competition may not motivate the development of new and improved production techniques and new and improved products. The product standardization associated with pure competition limits product variations, which provide consumers with a wide range of choice. Economists have recognized four possible deterrents to allocate efficiency in a competitive economy.