Perfectly Competitive Market

Perfectly competitive market

A market which converges all of below assumptions is called perfectly competitive market:

''Assumption 1. All the firms in the industry sell an identical or homogeneouse product.

Assumption 2. Buyers of the product are well informed about the characteristics of the product being sold and the prices charged by each firm.

Assumption 3. The output of each firm, when it is producing at its minimum long-run average total cost, is a small fraction of the industry's total output.

Assumption 4. Each firm is a price-taker. This means that each firm can alter its output without significantly affecting the market price of its product. Each firm must passively accept the existing market price, but it can sell as much as it wants at that price.

Assumption 5. There is freedom of entry and exit, which means that any new firm is free to enter the industry and start producing if it so wishes, and any existing firm is free to cease production and leave the industry.'' (Lipsey, Economics, eleventh edition, p.138, Oxford University Press, 2007)

Marginal cost and marginal revenue

In the perfectly competitive market where all firms operate under the same cost conditions, marginal cost is considered as the most important factor after price that affect the supply curve, and firms that cannot adopt the lowest cost methods of manufacturing are hard to maintain in this market. The goal of all firms is to maximise their profits which ''increases as long as marginal revenue exceeds marginal cost'' ( Greg Parry, Pathways in Economics, 5th edition, p.109, printed in WA by Lamb Print, Australia, 2000) and minimise marginal cost is defined as ''the change in total cost from the production of one extra unit of output'' (Greg Parry, Pathways in Economics, 5th edition, p.109, printed in WA by Lamb Print, Australia, 2000)

Therefore, when a new technology is available, the cost in production is saved, because with the same amount of money invested in production as before, the manufacturers now can produce more goods, hence raising supply. That leads to the decrease of marginal production cost as can be seen on the following graph. The initial marginal cost curve is MC1. Due to a fall in marginal costs in production, this curve shift to the right from MC1 to MC2.

That means the firm will produce more output at each price level.

Short run equilibrium

However, in the short run period, the inputs cannot be changed instandly. So with the same investment, firms can produce more goods and get over the normal profit. In this situation, the below diagram be the good explaination:

The new technology help firms to produce