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## Perfect competition

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# Free response question (FRQ) on perfect competition

## Video transcript

- [Instructor] This is
the type of question that you might see on
an AP Economics exam, and it's talking about
perfectly competitive markets. So it says, a typical
profit-maximizing firm in a perfectly competitive
constant-cost industry is earning a positive economic profit. So the first question they ask us is, is the market price
greater than, less than, or equal to the firm's price? Explain. So pause this video and
see if you can answer this on your own before we do it together. All right now let's do it together. So remember, we are talking about a perfectly competitive market. So in a perfectly competitive market, all of the players in that
market have to be price takers. They have no pricing power. So the market price has to
be equal to the firm's price. So market, market price equal, equal to firm price, firm price because in perfectly, perfectly competitive market, market, firms are price takers, firms are price takers. They have no pricing power. All right, part b. Draw correctly labeled
side-by-side graphs for both the market and a typical firm and show each of the following. And they ask us to do
a bunch of stuff here. So once again, pause this video
and actually get out paper. This will be very valuable
for you to have a go at this. All right, so let's see we wanna do these side-by-side graphs,
and we wanna think about the market and the firm. And we've done this in
multiple videos before. So let's think about what
they're talking about is, so this is the market right over here. That's the market. And this is, on this axis
is going to be price. On this axis is going to be quantity. And then let me do a similar
thing for a firm here. So that would be the
firm's price axis, price. And then this would be quantity
for the firm, quantity. Let me make it clear, this is the market, and then this right over here is the firm. And let's see, they say,
market price and quantity. So the equilibrium price
and quantity in the market. So we could draw the supply
curve for the market. It might look something like this, upward-sloping, we've
seen that multiple times. We could do the demand
curve for the market. It would look something like that. And then we have the
equilibrium price in the market, which they want us to
use P sub m, so P sub m. And then we have the equilibrium
quantity in the market, which they want us to use Q sub m. So we've done this first part. All right now let's see
what else they want. The firm's quantity, labeled Q sub f, the firm's average
revenue curve, labeled AR, the firm's average total
cost curve, labeled ATC, the area representing total
cost shaded completely. So in order to do this first part, the quantity that it would be rational for this profit-seeking firm
or the profit-maximizing firm to produce, to think about that, we'd actually also have to think about the firm's average revenue. And the average revenue, which
is going to be the same thing as the demand curve for that firm, is going to be based on this market price. Remember, the firm, in this
perfectly competitive market, has to be a price taker. So this horizontal line right over there, that is the firm's average revenue, AR, which is equal to its marginal revenue, which is equal to its demand curve, which is equal to this market price. And the quantity that it's
rational for this firm to produce is where this
marginal revenue curve, which is also the average
revenue curve in this case, intersects our marginal cost curve. So the marginal cost curve
might look something, something like this. So marginal cost. And so this right over
here is our Q sub f. So we've done this part and this part. The firm's average total cost curve, well the average total
cost at this quantity needs to be below the marginal revenue and the average revenue at that quantity because we know that the firm is earning a positive economic profit. So we are dealing with
a situation that likely looks like this. So the average total cost
might look something like this. And I drew it that way to
ensure that at this quantity, Q sub f, our marginal revenue
and our average revenue is above our average total cost. That tells us that we're
earning economic profit in this situation. So I've done part iv. The area representing total
cost shaded completely, well the area representing
total cost would be the cost per unit, the
average cost per unit, which is that much, times
the total number of units. And the total number of units
is going to be this length, which is equal to Q sub f. And so your total cost is
going to be this shaded area. If they were asking us
our total economic profit, then we would be talking
about this area up here, but they're not. They're talking about our total cost, which is this area right over there. So we have done those parts. Now let's go to part c. If one firm in the market
were to raise its price, what would happen to its total revenue? Explain. Pause this video, see
if you can answer that. Well remember, we're dealing with a perfectly competitive market, a perfectly competitive industry. There's no differentiation
between anyone's products. So if all of a sudden, someone
were to stick their head out and try to raise price, no one would buy their product anymore
because people can get identical products from other
people for a lower price. And so, its total revenue, its total revenue would go to zero since product is undifferentiated,
undifferentiated, and consumers could buy from others at lower price, at lower price. And this is another way to think about it. They have to be price takers in a perfectly competitive market.