Competitive Equilibrium
In 1999, the respective worldwide demand and supply curves for copper were: QD ⴝ 15 ⴚ 10P and QS ⴝ ⴚ3 ⴙ 14P, where Q is measured in millions of metric tons per year. Find the competitive price and quantity. Suppose that in 2000 demand is expected to fall by 20 percent, so QD ⴝ (.8)(15 ⴚ 10P) ⴝ 12 ⴚ 8P. How much are world copper prices expected to fall?
COMPETITIVE EQUILIBRIUM Perfect competition is commonly characterized by four conditions. 1. A large number of firms supply a good or service for a market consisting of a large number of consumers. 2. There are no barriers with respect to new firms entering the market. As a result, the typical competitive firm will earn a zero economic profit. 3. All firms produce and sell identical standardized products. Therefore, firms compete only with respect to price. In addition, all consumers have perfect information about competing prices. Thus, all goods must sell at a single market price. 4. Firms and consumers are price takers. Each firm sells a small share of total industry output, and, therefore, its actions have no impact on price. Each firm takes the price as given—indeed, determined by supply and demand. Similarly, each consumer is a price taker, having no influence on the market price. It is important to remember that these conditions characterize an ideal model of perfect competition. Some competitive markets in the real world meet the letter of all four conditions. Many other real-world markets are effectively perfectly competitive because they approximate these conditions. At present, we will use the ideal model to make precise price and output predictions for perfectly competitive markets. Later in this and the following chapters, we will compare the model to real-world markets. In exploring the model of perfect competition, we first focus on the individual decision problem the typical firm faces. Then we show how firm-level decisions influence total industry output and price.
Decisions of the Competitive Firm The key feature of the perfectly competitive firm is that it is a price taker; that is, it has no influence on market price. Two key conditions are necessary for price taking. First, the competitive market is composed of a large number of sellers (and buyers), each of which is small relative to the total market. Second,
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