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Model of Perfect Competition

Model of Perfect Competition. "In the beginning there was perfect competition.  And economists saw that it was good.  So they assumed perfect competition.". PC is almost never found in the real world, so why use it?. Easy to determine characteristics and/or predictions

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Model of Perfect Competition

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  1. Model of Perfect Competition "In the beginning there was perfect competition.  And economists saw that it was good.  So they assumed perfect competition." Col. Gutermuth - Health Econ

  2. PC is almost never found in the real world, so why use it? • Easy to determine characteristics and/or predictions • Can compare actual markets to PC and determine deviation from it • Can predict behavior based on how far a market deviates from PC Col. Gutermuth - Health Econ

  3. Assumptions • Homogeneous Products • Perfect Information • Price-taking Behavior • “many buyers and sellers” • No Transactions Costs • No Externalities • Free Entry and Exit Col. Gutermuth - Health Econ

  4. Firm Behavior Col. Gutermuth - Health Econ

  5. Why is P=MC “best”??? • Certainly, P > MC would produce higher profits, right??????? Col. Gutermuth - Health Econ

  6. Shut-Down Decision • Stay in business as long as • Revenues  TVC • pq  TVC • p  AVC • psd = min AVC Col. Gutermuth - Health Econ

  7. PC Industry • Short-Run Supply Curve • Horizontal summation of firms’ supply curves • No output for p < psd • For p > psd, all firms produce • Equilibrium p* and Q* determined by intersection of demand and supply Col. Gutermuth - Health Econ

  8. PC Industry • Long-Run Supply Curve • Positive Econ Profits  New firms enter •  Supply curve shifts out (and “flattens”) •  Price falls until Econ Profits = 0 • LRSC is horizontal at p* = min ATC • (constant cost industry) Col. Gutermuth - Health Econ

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