Perfect competition | Forms of competition | Microeconomics | Khan Academy

published on July 20, 2020

In pretty much all of the videos so far we've been assuming an economic ideal and that economic ideal is perfect perfect competition and perfect competition is exactly what you think it is competition but what I want to do in this video is think about it a little

Bit more exact terms in terms of what are the what are the ground rules we have need to have to really have this ideal perfect competition it's important to realize that there's very few markets that are truly perfectly competitive and

Those that are very good for consumers but there are that get very close to being perfectly competitive and if we have time we will discuss those in this video now to be perfectly competitive you have to have many competitors so one

Of the first stipulations is many many players many players and they need to be competing for the kind of the same buyer and kind of offering the same thing and so they need to have identical products identical products and remember this

We're talking about an economic ideal here there's very few top very few markets where the product is absolutely identical or the service is absolutely identical but we're talking about an economic ideal over here the next

Condition you need is no barriers to entry no barriers no barriers to entry so if at any given moment it looks attractive for other people to go into that market other people will go into that market and there's nothing that's

Really going to stop them if the firms that are already in the market are making an economic profit that means that that that it's that's good that's a it's a good option for people to do that that you can you can do better in this

Market than your opportunity costs and so people will enter into that market and in order for this market to be perfectly competitive we can't have any barriers nothing stopping those people on top of that there can be no advantage

For established firms no advantage advantage for existing firms for existing firms so once someone jumps into the fray and they are going to be and assuming that they're somewhat competent they are going to be able to

Compete on kind of equal terms with the people that are already there and then the last one and this is important this is important is that you have to have really good price information that the buyers and the

Sellers all have to know about each other's prices the buyers need to know all the prices so that they can really do good comparison shopping and the sellers need to know everyone's prices so that they can really match prices

Really well so good good price price information now there are many different types of markets that somewhat approximate perfect competition there very few that are completely purely perfect competition but one of them that

Does come to mind one of them that does definitely come to mind is the US airline industry and the US airline we can think about these different bullet points how closely it matches it there are definitely many different airlines

There are definitely many different airlines they don't offer identical products how I'm sure the airlines would take it would not agree they would say that they're differentiating on their service and what type of food they gave

Or I guess don't give to you or how much they're charging for the the baggage checking and all the rest but for the most for most consumers it looks like look I just want an economy class ticket from San Francisco to New York and they

View them as almost identical products so the airline industry does pretty well that's pretty well on this first point no barriers to entry well there are some barriers to entry in the airline industry you need a few billion dollars

That you need to either find or borrow or whatever so that you can buy the capital so you can start operating planes or I guess you could let rent the planes but either way you need a lot of capital to get into this business you

Need access to airport terminals that you'll have to lease and landing rights and all the rest so there are some barriers to entry but for the most part at least in the United States if you are a US a us operator and you know that

So there are some barriers to entry especially for foreign operators but if you are a us operator and you have the capital you will be able to be the next next Virgin America or Southwest Airlines or JetBlue so for them there

Are some barriers to entry but they're low it's not like the government is saying that no one else can start a new Airlines no advantage for existing airlines yeah that's somewhat true if I start a new Airlines tomorrow in it and

And and its offering comparable rates and comparable service I could imagine people would be willing to take this Airlines so the airline industry seems pretty good there and good price information

And this is why the airline industry definitely came to my mind because I can't imagine an industry where you have better price information that at least now after the internet came about than in the airline industry you want a

Flight from San Francisco to New York you go to any of these travel sites Orbitz kayak Expedia whatever you want to go to and you get all of the flights listed for you and they're listed by price that you can sort them by price

And you can actually pick you know you can you can and and it's known that people do this they pick the flight that might be five or six hundred dollars but they can compare based on a few pennies or even a few dollars so there's

Extremely good there is extremely good price information and obviously the sellers have all of their IT systems the airlines have all their IT systems to keep track of where airline prices are going as well so the air air travel

Industry like most industries it's not absolutely perfect competition but it gets pretty close to perfect competition and you even see that in the real world that's very hard for the airlines to make really a lot of profit and they're

Really and you know whether you're talking about accounting profit or even economic profit and you can see that when i from this supply and demand curve right over here so on this axis the horizontal axis this

Is the quantity this is a measure of the quantity of kind of airline service and we're measuring it in billions of seat miles per week and it I know that sounds like a strange thing but really we're just saying okay in a given week tell me

All of the seats that are in use and multiply those number of seats so the number is the seat miles in a given week the number of seats times the miles that the or the average miles per seat average miles miles per seat in a given

Week and that gives you how much air trial this is a measure of air travel and let's say in the US in that week and on this axis this is the price this is price per and this should actually say price per seat mile price per seat mile

And of course you have your supply curve right over here this is your supply curve at first to start providing those those first few miles it's relative the airlines are doing are willing to do that relatively in

Expensively maybe they're finding it from the most obvious airports that maybe the landing rights are cheaper it's cheaper to lease things or whatever but as they start doing running more and more and more routes maybe between

Smaller and smaller cities maybe smaller and less efficient planes it starts to become more and more expensive for them to supply those incremental miles and obviously on the demand side if air travel is very very expensive very few

People are going to want to travel there's going to be very little travel that happens if it's very cheap many people are going to want too many people are going to want to travel now let's say that this is this is where the

Market is right now obviously we have an equilibrium price we have an equilibrium price right over there and then we have an equilibrium quantity of seat miles but let's say let's say that the price level in order for the players to

Actually have an economic profit is over here so it is right over here so this is the price needed this is the price price needed for for zero economic profit or you could say for neutral economic profit or you could even say for normal

Profit for economic economic profit profit to be equal to zero so at that point if if that was if that is the price then then the firm's that are offering airline travels they're kind of neutral between shutting down and

Continuing to offer service but notice the way I've drawn it here that is substantially lower than the current equilibrium price so what this is saying is since the current equilibrium price is a good bit higher

Than this or it's just higher at all these firms in the market right now are generating economic profit definitely positive economic profit so what's happening if there's positive economic profit that means that there's an

Incentive for other firms to add to enter into to enter into this industry so what's going to happen is this is going to be the supply curve right at that moment but as soon as another carrier realizes that they can or any of

The carrier's realize they can offer more and it doesn't even have to be new carriers entering it could be existing carriers just offering maybe buying more planes or offering more then maybe a little bit later the supply

Curve shifts like this the supply curve shifts like that and then this would be our new equilibrium price and but we're still making economic profit because our new equilibrium price is still is still higher than the price needed for zero

Economic profit so still more people will continue to enter and so then you might have a new supply curve that looks like this and now this is our new equilibrium price and notice what's happening we're traveling we're

Traveling down to the right along the demand curve as as nor supply comes on we're obviously increasing the quantity and the price is going down but still the equilibrium price is higher than then this this line right over here so

Even more people will enter even more people will enter until we get to that point right over there and at that point now the equilibrium price is the price at which all of the players are having zero economic profit and there's no

Incentive for more more people to enter into it because then the equilibrium price will go down or they're essentially right now economic profit is zero so everyone is neutral in this scenario so I want to leave you there

This is what happens with perfect competition that there's there's no barriers to entry more people go in and in and in the price goes down the quantity will go up in this scenario but what I want to do in the next day just

Think about what if we didn't have perfect competition especially what happens if we have something like something like I don't know something like a monopoly

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