Market Equilibrium

In the long run, firms in competitive markets make zero economic profit

Suppose the current market price is high enough such that all firms in the industry are making a positive profit. This means the market price is above the lowest average cost
- Free entry allows any firm to enter the market
- Atomicity and equal access allow any single firm to make a positive profit with very little affect to the market price
- Eventually, so many firms enter the market that this competition drives the market price down until all firms earn zero profit
- When the market price creates zero profit, no new firm has incentive to enter and all active firms are indifferent between staying and leaving the market

Suppose the current market price is low enough such that all firms in the industry are making a negative profit. This means the market price is below the lowest average cost
- Free entry allows any firm to exit the market
- Atomicity and equal access allow any single firm to make a negative profit and their exit will affect the market price very little
- Eventually, so many firms exit the market that this lack of competition drives up the market price until all firms earn zero profit
- When the market price creates zero profit, no new firm has incentive to enter and all active firms are indifferent between staying and leaving the market

In a perfectly competitive market, the marginal revenue curve (market price) is tangent to the average cost curve at the lowest point
More on this later today

Not very often
- Atomicity fails when there are only a few firms
- Products are not always homogeneous (i.e. smart phones, cannabis, snowboards)
- Free entry is often violated by startup costs or exit costs (i.e. railroads, ski resorts)
Sometimes a subset of these assumptions will hold
- The market for minimum wage jobs (workers are very similar and have no pricing power)
- The agricultural market (products are homogeneous, costs are similar)
If these assumptions aren’t usually satisfied, then why do we care about this model?
- Perfectly competitive markets provide a useful benchmark
From the perspective of an economist,
- Perfectly competitive markets (theoretically) eliminate deadweight loss
- Deadweight loss is welfare that could be collected by society, but is not collected
- This is a market inefficiency
In order to formalize a measure of deadweight loss, we need to first discuss consumer surplus and producer surplus

Consider this market that is at a competitive equilibrium

At this price and quantity, quantity demanded equals quantity supplied
At p = 40, the maximum willingness to pay for 20 units is exactly equal to the minimum willingness to accept for 20 units
No firm has incentive to enter or exit the industry

Now consider a market that is NOT at a competitive equilibrium
At this price (p = 50), the price is higher than the competitive equilibrium (p = 40) and the quantity (q = 15) is less than the competitive quantity (q = 20)

Let’s break this graph into three separate regions
- Consumer surplus
- Producer surplus
- Deadweight loss
Deadweight loss is everything between the demand and supply curves that is not surplus
The perfectly competitive outcome is socially optimal, as there is no deadweight loss
In this class, we will discuss court cases and their impact on society
We will use economic models to analyze these cases in terms of deadweight loss and its impact on various economic agents (i.e. consumers, other firms, society)