Why It Matters: Perfect Competition

Why analyze a firm’s profit maximizing decisions under conditions of perfect competition?

This module is the second in the theory of the firm and the first of four modules examining models of market structure. Market structure means, in a nutshell, how competitive or monopolistic is a particular industry. It should be clear that market structure influences how firms behave.

We start by looking at the ideal model of perfect competition. This model is a bit of a head scratcher since there are, actually, very few examples of industries like this in the real world. Why then do we study it? Here’s a question for you to think about as you move through the module: What’s so perfect about perfect competition? Hint: the model has certain ideal features that you will learn.

Four pictures in a collage. The largest picture show a sign in neon lights advertising a Farmer's Market in Jefferson County, then the three others show tomatoes piled up and ready to be sold at a market.

Tomato Collage. Farmer’s Market by Andre Natta, CC-BY. Firey Tomatoes by Swaminathan, CC-BY. NorthCharleston Farmer’s Market by NorthCharleston, CC-BY-SA. What’s Better than Love CC torbakhopper, CC-BY.

Have you ever noticed that all the tomatoes of the same type in a farmer’s market cost about the same price? The same thing is true of roadside vegetable stands in the countryside. If one stall in a locality has tomatoes for $3 per pound, they all do.  Now the price may change from week to week, but it’s always the same across the different vendors in the market. You will soon learn why this is.

There are more similarities than differences between this and the following three modules. What you learn in this module will carry over and help you understand the next ones, so the more effort you put into learning this one, the easier the next three modules will be.

LEARNING OUTCOMES

  • Define the characteristics of Perfect Competition
  • Understand the difference between the firm and the industry
  • Calculate and graph the firm’s fixed, variable, average, marginal and total costs
  • Measure variable and total costs as the area under the average variable and average total cost curves
  • Determine the break-even, and the shutdown points of production for a perfectly competitive firm
  • Explain the difference between short run and long run equilibrium
  • Understand why perfectly competitive markets are efficient