Abstract
Competition is a fundamental concept in a market economy. We can think of competition as firm rivalry, where one firm battles to gain a strategic advantage over its competitors. For example, General Motors and Ford have been competing with one another for over a century to produce better cars at lower cost and to create more catchy marketing campaigns. We can also think of competition as a type of market structure. Both concepts are important in industrial organization. In later chapters, we analyze various forms of competitive behavior. In this chapter, we review the market structure of perfect competition.
This is a review chapter. You can learn more about the basic economic models discussed in the chapter from any introductory or intermediate microeconomics textbook, such as Frank and Bernanke (2008), Mankiw (2011), Bernheim and Whinston (2008), Pindyck and Rubenfield (2009), and Varian (2010). For more advanced treatments, see Nicholson and Snyder (2012) and Mas-Colell et al. (1995).
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Notes
- 1.
In Chap. 2 we discuss alternative firm motives.
- 2.
The model also assumes that there are many buyers. Unless otherwise indicated, we will assume many buyers throughout the book.
- 3.
Although q is the only variable in this example, we use ∂ instead of d to remind us that there are many other variables that are implicitly assumed to be held fixed.
- 4.
Generally, we will consider long-run problems, but at this point, we are abstracting from time.
- 5.
A maximum is assured because the profit equation is concave. If it were convex, this method would identify the output level that would minimize profit. See the Mathematics and Econometrics Appendix at the end of the book for more details.
- 6.
These functions derive from the following total revenue, total cost, and profit functions: \( TR = 2q, \) \( TC = {q^2}, \) and \( \pi = TR - TC = 2q - {q^2}. \) The TC equation is not the usual representation of a cost equation in perfect competition, as we will see subsequently, but we use it here to provide a simple example.
- 7.
In the short run, the firm must pay its fixed costs whether it shuts down or not. In this case, the firm would shut down if its losses from staying in business were less than its fixed cost, which it cannot avoid.
- 8.
This differs from the short-run supply function. Recall from principles of economics that a firm’s short-run supply curve is its marginal cost curve above average variable cost. The short-run industry supply curve is the (horizontal) summation of the marginal cost curves of every firm in the industry. Thus, it reflects the industry’s marginal cost of production.
- 9.
The third is the decreasing-cost case.
- 10.
To see the result more clearly, we leave off the MC1 and MC2 curves.
- 11.
The third case involves decreasing costs. That is, input prices fall as industry production increases. The usual example given to justify this possibility is the presence of economies of scale in the production of a primary input. Scale economies cause the input price to fall with increased production, and the long-run supply function has a negative slope.
- 12.
For a decreasing-cost industry, \( \partial {Q_{\rm{s}}}/\partial p \,<\, 0 \) and \( {\epsilon_{\rm{s}}} \,<\, 0. \)
- 13.
This would be true, for example, for commodities that are not reproducible, such as van Gogh paintings.
- 14.
- 15.
- 16.
Here, we mean that the perfectly competitive model is statically efficient, but it need not be dynamicaly efficient as we will see in later chapters.
- 17.
- 18.
When PS is positive, as it is in this example, it is called economic rent. Even when economic profit is zero, firms may earn “economic rent.” That is, an entrepreneur may enjoy owning a company so much that he or she is willing to earn only 8% on invested financial capital, even though the normal rate is 10%. If the owner does earn 10%, the 2% above the owner’s opportunity cost is rent, not profit. Note that the concept of economic rent is different from the rent you pay on an apartment.
- 19.
As discussed in Chap. 1, just because markets fail to reach an ideal does not mean that government intervention can improve welfare. We ignore this issue here, but take it up more thoroughly in later chapters.
- 20.
For a review of the economics of networks, see Shy (2011).
- 21.
We will see that producers of high quality goods can solve this information problem by offering guarantees or warranties.
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Tremblay, V.J., Tremblay, C.H. (2012). Perfect Competition and Market Imperfections. In: New Perspectives on Industrial Organization. Springer Texts in Business and Economics. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-3241-8_5
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