#AP Microeconomics: Perfect Competition - Your Ultimate Review 🚀

Hey there, future econ whiz! Let's dive into the world of perfect competition, the foundation of many economic models. This guide is designed to be your go-to resource, especially when you're cramming the night before the big exam. We'll make sure everything clicks!

#Market Structures Overview

In economics, every good or service is sold within a market structure. The four main types are:

• Perfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly

These structures differ based on:

• Number of firms
• Barriers to entry/exit
• Control over price
• Product differentiation

Let's focus on perfect competition first!

#Perfect Competition: The Basics

Perfect competition is like the ideal world of economics—lots of players, no one has an edge, and everything is super efficient. Here's the lowdown:

#Key Characteristics

• Many Small Firms: Think hundreds or thousands of tiny businesses, none big enough to influence the market.
• Price Takers: Firms have zero control over price. They sell at whatever the market dictates.

* **Low Barriers to Entry/Exit**: Easy for new firms to join or leave the market. No crazy obstacles. * **Long-Run Break-Even**: Firms make *normal* profit (zero economic profit) in the long run. * **Identical Products**: Goods are exactly the same, like oranges at the grocery store. * **No Non-Price Competition**: No need for advertising or fancy marketing, since products are identical. * **Perfectly Efficient**: In the long run, firms are both **allocatively** (P=MC) and **productively** (P=min ATC) efficient.

#Side-by-Side Graphs: The Perfect Competition Signature

Perfect competition is unique because we use side-by-side graphs to show the market and the individual firm. This helps illustrate how the market price affects the firm.

• Left Graph (Market): Standard supply and demand curves.
• Right Graph (Firm): A horizontal (perfectly elastic) price line that is also the firm's demand (D) and marginal revenue (MR) curve.

#Short-Run Scenarios: Profit, Loss, or Shutdown?

In the short run, a perfectly competitive firm can experience three different situations:

1. Short-Run Profit: Price is above the ATC at the profit-maximizing quantity (MR=MC).
2. Short-Run Loss: Price is below the ATC but above the AVC at MR=MC.
3. Shutdown: Price is below both ATC and AVC at MR=MC. The firm is better off not producing in the short run.

#Long-Run Equilibrium: The Sweet Spot

In the long run, perfectly competitive firms reach equilibrium where:

• Price (P) is tangent to the minimum point of the Average Total Cost (ATC) curve at the profit-maximizing quantity (MR=MC).
• This point is both allocatively efficient (P=MC) and productively efficient (P=min ATC).

#Shifting from Short-Run to Long-Run

The market is always moving towards long-run equilibrium. Here’s how:

• Short-Run Profit Attracts Entry:
  • New firms enter the market, increasing supply.
  • Market price decreases.
  • Firm's price line shifts down until it's tangent to the ATC.
  • Firms return to zero economic profit.
• Short-Run Loss Causes Exit:
  • Firms leave the market, decreasing supply.
  • Market price increases.
  • Firm's price line shifts up until it's tangent to the ATC.
  • Firms return to zero economic profit.

#Long-Run to Short-Run and Back: Demand Shifts

Sometimes, you'll start in long-run equilibrium, then demand changes, shifting the market to the short run, before it readjusts back to long-run. Let's see how this works:

Example: Increased Demand for Apples

1. Start in Long-Run Equilibrium: The apple market is in long-run equilibrium.
2. Demand Increases: The price of peaches increases (a substitute for apples), causing demand for apples to rise.
   • Market demand curve shifts right, increasing the equilibrium price.
   • Firm's price line shifts up, creating a short-run profit.
3. Return to Long-Run: The short-run profit attracts new firms.
   • Market supply curve shifts right, decreasing the equilibrium price.
   • Firm's price line shifts down until it's tangent to the ATC, returning to long-run equilibrium.

#Final Exam Focus

• Graphing: Practice drawing and interpreting side-by-side graphs for short-run profit, loss, shutdown, and long-run equilibrium.
• Efficiency: Understand allocative (P=MC) and productive (P=min ATC) efficiency.
• Market Adjustments: Know how changes in demand or costs shift the market from short-run to long-run.
• Key Terms: Be fluent with terms like "price taker," "barriers to entry," "economic profit," and "normal profit."

Practice Question

#Practice Questions

#Multiple Choice Questions

1. Which of the following is a characteristic of a perfectly competitive market? (A) High barriers to entry (B) Differentiated products (C) Firms are price takers (D) Few firms in the industry (E) Firms earn economic profit in the long run

2. In a perfectly competitive market, if a firm is earning a short-run profit, what will happen in the long run? (A) Firms will exit the market, decreasing supply. (B) New firms will enter the market, increasing supply. (C) The firm's costs will increase. (D) The market price will increase. (E) The firm will continue to earn a profit.

3. A perfectly competitive firm is in long-run equilibrium. Which of the following is true? (A) Price is greater than marginal cost. (B) Price is equal to the minimum average total cost. (C) The firm is not allocatively efficient. (D) The firm is not productively efficient. (E) The firm is earning an economic profit.

#Free Response Question

Assume the market for wheat is perfectly competitive.

(a) Draw correctly labeled side-by-side graphs for the wheat market and a representative wheat farmer in long-run equilibrium. On your graphs, label the following: * Market price and quantity as Pm and Qm * Firm's price and quantity as Pf and Qf * The firm's marginal cost curve (MC) * The firm's average total cost curve (ATC)

(b) Assume there is a decrease in the demand for wheat. Show the effect of this change on your graphs from part (a). Label the new market price and quantity as P2 and Q2, and the new firm price and quantity as P3 and Q3. (c) Explain what will happen in the long run in the wheat market.

#FRQ Scoring Breakdown

(a) (5 points)

• 1 point: Correctly labeled market graph with downward-sloping demand and upward-sloping supply.
• 1 point: Correctly labeled firm graph with a horizontal demand/MR curve.
• 1 point: Market equilibrium price and quantity labeled as Pm and Qm.
• 1 point: Firm equilibrium price and quantity labeled as Pf and Qf.
• 1 point: Correctly drawn MC and ATC curves with MC intersecting ATC at its minimum.

(b) (4 points)

• 1 point: Shift the market demand curve to the left, showing a decrease in demand.

• 1 point: New market equilibrium price and quantity labeled as P2 and Q2. * 1 point: Firm's new price line (P3) is lower than the original price line (Pf).

• 1 point: New firm quantity labeled as Q3. (c) (2 points)

• 1 point: Explanation of firms exiting the market due to losses.

• 1 point: Explanation of market supply shifting left, increasing market price until firms reach long-run equilibrium (zero economic profit).

#Answers

Multiple Choice:

1. (C)
2. (B)
3. (B)

#Wrapping Up

You've got this! Perfect competition might seem complex, but with a clear understanding of the core concepts and practice with graphs, you'll be ready to ace the exam. Remember to stay calm, manage your time wisely, and trust your preparation. You're going to do great! 💪