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In any case, the conditions for perfect compedtion are: Homogeneity of product i.e., the product is either identical or perceived as identical; Free Resource MobiJif). i.e.. participants must be free to enter and leave markets subject onK to nieeiing contractual commitments; Good Informadon, i.e., buyers and sellers must be well auare oftheir aliernati\es; and Large Numbers of Buyers and Sellers, i.e., there nuist be a sufficiendy large number of buyers and sellers so diat none have anv independent influence or control over price (see end of section). These condidons are clearly extreme. Nonetheless, the perfect competition model is useful not only because several real word industries approach perfect competition, but also because the model represents a standard against which other market structures can be judged.

The middle panel of Figure XII presents an overview of the competiti\e market for widgets. An equilibrium price of P emerges and an equilibrium quandty of Q widgets is exchanged in the market. Three of the very man\ firms and households are depicted to the left and right of the center panel. Since so many firms and households consdtute the market, the quandty scale in the firm and household graphs must be considered much smaller than that of the market graph. For example, 1/4 inch may represent 10 widgets in the household diagram but perhaps 1000 in the market diagram. At the going market price of P, firm I is willing to supply qi widgets; firm 2, qs; and firm 3 is unwilling to supply any at that price. This is the basic answer to the what quesdon: Q widgets will be produced and consumed.

The right hand panels answer the who question. Out of the total of Q widgets sold, household A

will buy qa, household will buy q, and household will buy none. Using the relation P = MB (price equa marginal benefit), we see that households A and wIiq value die good the most as seen by their denraad curves are the ones who receive it. Household wit}) its lower demand doesnt receive any of the good Thus, goods aiiioiiiatically flow to the highest valued uses, in this case households A and B. Moreover, the subjective value (marginal benefit) placed on having the last unit of the good is the same in households A and B. This must be so: if household A valued its last widget as worth, say $10 and household valued hav- iug another widget at $15. then household A could resell to household for some price between $15 and SIO, thereby making both better off On the other! hand, if they both valued having another widget SIO. then neither could re.sel! to the other, which is say that the gains from trade wotdd be exhausted. In! the graph, households A and pay the same price, their subjective values for die verv last widget boughl are the same; no furdier gains from trade are possible!

Wliile in Figure XII the value (MB) ofthe I. widget is identical for all households receiving widge unequal marginal benefits occur when a ceiling pri( is placed on a product. Imagine the governmi imposes a price ceiling on gasoline; after iioii-pri compedtion arises, those who value gasoline the mi will not necessarily receive it. For exampfe, while person who values another gallon at $1.50 may not be able to buy it, someone else who values an er gallon ai-$1.00 often can. Even if the governnie allows resale, the transacdons costs of reselling ft low to high valued users may o\erpower the gains fi trade when die pardes spend dme searching for ea

Fog. XII The Product Martcet

Firm 1 Firm 2


Houseliold A Housetiold tlousetiold


supply of Equilibrium

Fig. XII The Labor Market


Firm 2


Household A Household Household

V .....



: "2



Man Hours

Other and siphoning gas from tank to tank.

Saying that the price system causes goods to f flow to their highest ralued uses does not mean that those who receive the goods necessarily enjoy them I the most. There is no way we can tell who receives the most udlity from the goods. What we can say is that "those who value the goods the most, in the sense of being most willing to forego other goods to have the good of choice, will end up with the good. In the absence of a giant advance in mind reading, we know of no better way to measure how much you subjectively value a good than to see what you would give up in prder to get it. Conversely, regardless of what you may have to say on the subject, we question your regard for your country, family, dog, or the poor ifyou are unwilling to give up anything on their behalf

Figure Xll also presents a partial answer to the how question: under competitive capitalism only the firms \>9Uing to supply the good at the least cost to consumers do .so. In the graph Firm 3 would have required more than the other two firms for supplying any widgets. Since the market was not willing to pay that much, this high cost seller did not supply anything. This illustrates that goods tend to be produced under the least cosdy method under compedtive capitalism; more will be said on this subject in Section V.


Figure xm presents an overview of the competitive labor market. The going rate, W, represents the ciurent price of labor services. At this price, the equilibrium quantitv of labor employed wil! be N, biu firms 1, 2, and 3 will demand uj and zero, respectively. Similaily, at the same wage hou.seholds A, B, and

will respecti\ely supply and zero man hours.

Although Figures XII and XIll are among the two most fundamental in the Principles Course, they are both incomplete overviews. In order to fill out the analysis, demand and supply will be further chaiacter-ized and manipulated in Secdon FV. Secdon V presents firm supply in greater detail. Next we consider and evaluate noncompedtive markets in Secdons VI and \T1. We leave the product market and turn to the labor market in Secdon VIII. Finally, in Section IX we consider market effects on outside pardes.


It is crucially important to distinguish between die market supply and demand curves and die corresponding curves faced by individual price-taking buyers and sellers. All price-taking buyers face flat supply curves, and all price-taking .sellers face flat demand curves. For example, back in Figure XII the supply curve faced by each individual household is die dashed horizontal line at P. Similarly, the demand curve faced by each individual firm in this figure is also given by the flat dashed line at P. You can see that both curves must 1 flat since price-taking implies the unlimited abilit} to buy or sell as much as desired at the going price P.

But how can a supply curve diat is upward slof> ing in die market panel become flat to the individual households on the right hand side? The simple answer is that strictly speaking it cant. Nonetheless, each household comprises such a negligible portion of the overall supply/demand picture, diat its own actions cause a wholly miniscule impact upon die supply price. While a household must bid up the price of toothpaste in order to consume a few more tubes, the effect is so

Supply &" EfjuiUbiiui

Fig. XIV Market Supply and the Supply Curve faced by a Price-Taking Household

Induslry Supply

small (a billionth of a penny?) that we ignore it completely and just say the price to the household is P.

Figure XFV models the situation. A tiny distance in the market scale would be a giganuc and impossible quantity for the household to buy. Consequendy, the rise along the price-taking households supply curve in Figure XFV is too gende to be consequendal. Similarly, given our assumption of many homogeneous firms, each individual firm has equally negligible influence upon market price. As a result, die demand curve faced by the price-taking firm is effectively, but not actually, flat at P; the firm carLsell everything its capable of producing at this price. The supply curve of labor faced by the price-taking firm and the labor demand curve faced by the price-taking household in Figure XIII are likewise both flat at the going wage \.

Since price-taking buyers can purchase all they like at the going price and priceiaking sellers can sell all they wish at the going price, die price-taking buyer would refuse to buy at one cent abo\e that price and the price-taking seller would refuse to sell at one cent below. Moreover, since their reactions are limited to deciding the quantity they wish to buy or sell, they are often called price-taker-quantit)-adjusters. Anyone who buys or sells under conditions of pure competi-

tion qualifies as a price-taker.

Price-Makers Demand Curves

WTiile price-taking sellers can pick the quaniityl they wish to sell but not the price, other sellers, terrnedf price-makers or price-searchers can pick either thej price or the quantity but not both. The difference aris.1 es because price-making firms face downward slopingj demand curves. Figure XV models the situation.

Mere an individual firm faces the demand curve d. Suppose the firm wishes to sell the quantity! (Well not inquire why it should wish to do so.) Thcr is one and only one price at which all q units will exa ly clear the market, the price P. For example, if should want to sell these q units at the higher price ( P, the firm would be unable to sell them all;, ther would be excess supply of q - q units. Consequendy,! it wants to sell q units, the firm will have to accept i lower price P. Conversely, if it wants the higher prio P, it must accept the lesser quantity q. This pric searcher cannot have both P and q, which is to that in general it cannot pick both the price and quantity: The preferences of demanders restrain options of the seller. We shall have a good deal to say about price-makers in Sections VI and VII, we will return to price-takers for the time being.

Fig. XV A Price-Makers Demand Curve

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