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In this Lecture we introduce the concept of "perfect competition."  Let's first learn what "competition" is, and let's learn it well.

In this Lecture we introduce the concept of "perfect competition."  Let's first learn what "competition" is, and let's learn it well.

According to the dictionary, "competition" was not first used in 1605.  Shakespeare had completed nearly all his plays by then, and a search of all of Shakespeare's works reveals that he never used the word, not even once.<ref>http://www.opensourceshakespeare.org/</ref>  Imagine that: Shakespeare knew nothing of the word.

According to the dictionary, "competition" was first used in 1605.  Shakespeare had completed nearly all his plays by then, and a search of all of Shakespeare's works reveals that he never used the word, not even once.<ref>http://www.opensourceshakespeare.org/</ref>  Imagine that: Shakespeare knew nothing of the word.

But perhaps competition has always existed.  Leonardo da Vinci competed with Michelangelo, and the world benefited from their achievements.  In math and physics, Isaac Newton competed with Gottfried Leibniz and a wellspring of accomplishments flowed.  Sports rivalries are famous also for bringing out the best in each side.

But perhaps competition has always existed.  Leonardo da Vinci competed with Michelangelo, and the world benefited from their achievements.  In math and physics, Isaac Newton competed with Gottfried Leibniz and a wellspring of accomplishments flowed.  Sports rivalries are famous also for bringing out the best in each side.

We all think we know what "competition" is, but can we define it precisely?  Here's one attempt:  "competition is the rivalry by people or companies for achievement, success, customers, attention or praise."  We could define competition in other ways, by using other powerful terms developed in this course.  For example, we could define competition in terms of efficiency:  "competition is the process that most efficiently rewards the best."

We all think we know what "competition" is, but can we define it precisely?  Here's one attempt:  "competition is the rivalry by people or companies for achievement, success, customers, attention or praise."  We could define competition in other ways, by using other powerful terms developed in this course.  For example, we could define competition in terms of efficiency:  "competition is the process that most efficiently rewards the best."

When we are a customer, we like competition for our spending money.  Competition means companies will be constantly trying to offer a lower price and better deal than their rivals.  That saves us money, as customers, and allows us to obtain better goods and services.  Without the competition, we would be stuck with companies charging as much as they like, and providing as poor quality goods and services as they want.  Competition rewards hard work; a lack of competition encourages laziness.

When we are a customer, we like competition for our spending money.  Competition means companies will be constantly trying to offer a lower price and a better deal than their rivals.  That saves us money, as customers, and allows us to obtain better goods and services.  Without the competition, we would be stuck with companies charging as much as they like, and providing as poor quality goods and services as they want.  Competition rewards hard work; a lack of competition encourages laziness.

The economic definition of competition should include rivalry for resources in addition to customers, as companies can compete with each other for workers too.  So let's define competition in economics as the "rivalry for goods, services or resources among different buyers or sellers."  Perhaps you can improve further on that definition.

The economic definition of competition should include a rivalry for ''resources'' in addition to a rivalry for ''customers'', as companies compete with each other for workers too.  So let's define competition in economics as the "rivalry for goods, services or resources among different buyers or sellers."  Perhaps you can improve further on that definition.

It often helps to look at an ideal case, and that is "perfect competition."  How should we define that?

It often helps to look at an ideal case, and that is "perfect competition."  How should we define that?

1.  '''Many buyers and sellers.'''  You can't have perfect competition without a lot of competitors!  In a classroom situation, two or even five students competing for a good grade may not be enough.  If a few get lazy, then all may stop working.  But in a large group of students, you can be sure that some are working hard.  Similarly, the more gas stations in an area, the more the competition for customers of gasoline.

1.  '''Many buyers and sellers.'''  You can't have perfect competition without a lot of competitors!  In a classroom situation, two or even five students competing for a good grade may not be enough.  If a few get lazy, then all may stop working.  But in a large group of students, you can be sure that some are working hard.  Similarly, the more gas stations in an area, the more the competition for customers of gasoline.

2.  '''Goods that are perfect substitutes for each other.'''  The ability to substitute one for the other is what makes the market so perfectly competitive.  Pencils are so inexpensive because there are so many perfect substitutes for them, as one brand of pencil substitutes easily for another.  Note that any variance in quality would prevent perfect substitution, and frustrate perfect competition for a particular level of quality; if there were only one brand for a high-quality pencil, then there would not be perfect competition for it.

2.  '''Goods that are perfect substitutes for each other.'''  The ability to substitute one good for the other is what makes the market so perfectly competitive.  Pencils are so inexpensive because there are so many perfect substitutes for them, as one brand of pencil substitutes easily for another.  Notice that any variance in quality would prevent perfect substitution, and frustrate perfect competition for a particular level of quality; if there were only one brand for a high-quality pencil, then there would not be perfect competition for it.

3.  '''Perfect knowledge in the market.'''  Fully informed consumers and suppliers are also necessary for perfect competition.  If Wendy’s is selling a hamburger at a lower price than McDonald’s or Burger King, but no one knows about Wendy's, then the competition is not going to be perfect.  McDonald's and Burger King would be able to continue to sell overpriced hamburgers.

3.  '''Perfect knowledge in the market.'''  Fully informed consumers and suppliers are also necessary for perfect competition.  If Wendy’s is selling a hamburger at a lower price than McDonald’s or Burger King, but no one knows about Wendy's, then the competition is not going to be perfect.  McDonald's and Burger King would be able to continue to sell overpriced hamburgers.

== Example of Perfect Competition: Sports ==

== Example of Perfect Competition: Sports ==

Let's look at sports and see if it qualifies as "perfect competition" among athletes:

Let's look at sports and see if it qualifies as "perfect competition":

1.  Many buyers and sellers?  Yes.  There are many teams competing for support of fans, and many fans choosing between different teams to support.

1.  Many buyers and sellers?  Yes.  There are many teams competing for support of fans, and many fans choosing between different teams to support.

4.  Perfect mobility of resources?  Pretty much "yes" again, as each team has tryouts and participates in a massive draft of college players every year.

4.  Perfect mobility of resources?  Pretty much "yes" again, as each team has tryouts and participates in a massive draft of college players every year.

But wait, you say, there is only one NFL.  It looks like there is perfect competition ''within'' the NFL, but there is no other league that has perfect competition with the NFL.  That is true:  the NFL itself has little or no competition.  There was a USFL that tried to compete against it many years ago, but it failed.  In the 1960s, there was an "AFL" that did successfully compete against the NFL, and they merged to form what we call the NFL today.

But wait, you say, there is only one NFL.  It looks like there is perfect competition ''within'' the NFL, but there is no other league that has perfect competition with the NFL.  That is true:  the NFL itself has little or no competition.  There was a USFL that tried to compete against it many years ago, but it failed.  In the 1960s, there was an "AFL" that did successfully compete against the NFL, and they merged to form what we call the NFL today.  Now the NFL as a whole has almost no competition.

Consider these two alternatives for picking players for a new football team.  The first approach would be to decide who you think would do best for each position based on their family background, their height and weight, an interview, and your intuition.  The second approach would be to have tryouts for each position and select the player who did the best at the tryout competitions.  Obviously the result would be much better with the second approach, as many players would be surprisingly good (or bad) at certain positions and it would become obvious during the competition.  Similarly, use competition for your own benefit to obtain the best.

Consider these two alternatives for picking players for a new football team.  The first approach would be to decide who you think would do best for each position based on their family background, their height and weight, an interview, and your intuition.  The second approach would be to have tryouts for each position and select the player who did the best at the tryout competitions.  Obviously the result would be much better with the second approach, as many players would be surprisingly good (or bad) at certain positions and it would become obvious during the competition.  Similarly, use competition for your own benefit to obtain the best.

Opponents of competition say it is wasteful to have multiple people or companies produce the same thing.  Or they do not like the way that competition causes someone to lose.  Many parents oppose competition in school, because for every winner there is a loser, and that might be their child.  Actually, in difficult competitions there can be dozens of losers for every winner.  Tournaments, for example, have one winner but many losers.

Opponents of competition say it is wasteful to have multiple people or companies produce the same thing.  Or they do not like the way that competition causes someone to lose.  Many parents oppose competition in school, because for every winner there is a loser, and that might be their child.  Actually, in difficult competitions there can be dozens of losers for every winner.  Tournaments, for example, have one winner but many losers.

However, the same people who oppose competition in business or school can be found watching professional sporting events like the Super Bowl, or entertainment competitions like American Idol.  If they are having a medical operation, wouldn’t they want the doctor who had the best grades and track record?  Or if they are flying on an airplane, wouldn’t they want the pilot who did the best in flight school and on the job?  If competition there is acceptable, then why not in business and school also?

However, the same people who oppose competition in business or school can be found watching professional sporting events like the Super Bowl, or entertainment competitions like American Idol.  If they are having a medical operation, wouldn’t they want the doctor who had the best grades and surgical record?  Or if they are flying on an airplane, wouldn’t they want the pilot who did the best in flight school and on the job?  If competition there is acceptable, then why not in business and school also?

Competition, in fact, yields enormous benefits for the losers as well as the winners.  Competition is a great motivator.  It is also an essential part of the “invisible hand” that channels work and supplies towards their most useful purposes.  Competition increases efficiency.  Competition encourages innovation.  It allows to people to do what was thought to be impossible.  Whenever we are beaten by a competitor, and all of us experience that many times, we are left to ask ourselves why our competitor was better than we were.  Next time, we can do better.

Competition, in fact, yields enormous benefits for the losers as well as the winners.  Competition is a great motivator.  It is also an essential part of the “invisible hand” that channels work and supplies towards their most useful purposes.  Competition increases efficiency.  Competition encourages innovation.  It allows to people to do what was thought to be impossible.  Whenever we are beaten by a competitor, and all of us experience that many times, we are left to ask ourselves why our competitor was better than we were.  Next time, we can do better.

The U.S. Constitution itself can be understood as system using competition for power to prevent anyone from becoming too powerful.  It established three separate branches of government to serve as checks and balances on each other.  No individual or branch can grab too much power because the system protects and promotes competition.

The U.S. Constitution itself can be understood as system using competition for power to prevent anyone from becoming too powerful.  It established three separate branches of government to serve as checks and balances on each other.  No individual or branch can grab too much power because the system protects and promotes competition.

Competition is also a great way to motivate yourself.  Virtually no one likes to work or study.  But people dislike losing even more.  Look around at achievements by others and then ask yourself: why not me?  Sometimes, the achievers are those who overcome the greatest obstacles.  At a local grocery store, the fastest checkout clerk has only one good arm.  Yet he is more efficient than all the other clerks who have two good arms.  Frequently the best athlete is the one with less God-given skills than others.  Rather, the best athlete is often the one who tries the hardest, both in practice and in the game.  The same is often true for the best student and the best business.

Competition is also a great way to motivate yourself.  Few like to work or study.  But people dislike losing even more.  Look around at achievements by others and then ask yourself: why not me?  Sometimes, the achievers are those who overcome the greatest obstacles.  At a local grocery store, the fastest checkout clerk has only one good arm.  Yet he is more efficient than all the other clerks who have two good arms.  Frequently the best athlete is the one with less God-given skills than others.  Rather, the best athlete is often the one who tries the hardest, both in practice and in the game.  The same is often true for the best student and the best business.

In business, the major beneficiaries of competition are the most efficient companies and the consumers.  The more competition by grocery stores in town, for example, the lower their prices are likely to be for the consumer.  The most efficient grocery store (including considerations like location) will likely be the most profitable and the one that lasts the longest.  Businesses know that they have to work hard to beat their competition.  Without that competition, it would be very unpleasant for us to shop for goods and services.  Communist countries have little competition and many unsatisfied consumers.

In business, the major beneficiaries of competition are the most efficient companies and the consumers.  The more competition by grocery stores in town, for example, the lower their prices are likely to be for the consumer.  The most efficient grocery store (including considerations like location) will likely be the most profitable and the one that lasts the longest.  Businesses know that they have to work hard to beat their competition.  Without that competition, it would be very unpleasant for us to shop for goods and services.  Communist countries have little competition and many unsatisfied consumers.

He did not give up.  The high jump event, like most sports events, is perfectly competitive.  There are (1) many participants, (2) athletes who serve as perfect "substitutes" for each other, (3) perfect knowledge in the market (everyone knows what the rules and conditions are), and (4) perfect mobility of resources (everyone has the same access to training opportunities).

He did not give up.  The high jump event, like most sports events, is perfectly competitive.  There are (1) many participants, (2) athletes who serve as perfect "substitutes" for each other, (3) perfect knowledge in the market (everyone knows what the rules and conditions are), and (4) perfect mobility of resources (everyone has the same access to training opportunities).

Motivated by the opportunity of perfect competition, Fosbury developed a revolutionary style of high jumping.  He started jumping back-first over the high bar.  Though lacking in athletic gifts of his competitors, the young man improved his jumping ability by a foot, and then even more.  He began to win.

Motivated by the opportunity of perfect competition, Fosbury developed a revolutionary style of high jumping.  He jumped back-first over the high bar.  Though lacking in athletic gifts enjoyed by his competitors, this young man improved his jumping ability by a foot, and then even more.  He began to win.

His peculiar style attracted mockery and name-calling, as people derided his technique as the "flop".  But he showed he did have a special characteristic that others lacked:  he did not allow the mockery to bother him.  He continued to jump in the direction opposite to all his competitors.  With his unique invention of jumping back-first, he won the national college high jump event.  But experts still considered his success to be a fluke and his approach to be a joke.  They still refused to take Fosbury or his "flop" seriously.

His peculiar style attracted mockery and name-calling, as people derided his technique as the "flop".  But he showed he did have a special characteristic that others lacked:  he did not allow the mockery to bother him.  He continued to jump in the direction opposite to all his competitors.  With his unique invention of jumping back-first, he won the national college high jump event.  But experts still considered his success to be a fluke and his approach to be a joke.  They still refused to take Fosbury or his "flop" seriously.

== Review: Cost Measures ==

== Review: Cost Measures ==

Let's pause for a moment and review some concepts from the last class.  Imagine you are the owner of a firm.  You want to understand all your costs.  There are seven basic types of costs for a firm, also known as "cost measures:

Let's pause for a moment and review some concepts from the last class.  Imagine you are the owner of a firm.  You want to understand all your costs.  There are seven basic types of costs for a firm, also known as "cost measures":

* marginal cost (MC)

* marginal cost (MC)

*MC is the difference in cost between the specified Q and the good produced before it

*MC is the difference in cost between the specified Q and the good produced before it

In perfect competition, firms sell more and more Q until MR (marginal revenue) falls to the level of MC (marginal cost).  Stated another way, firms sell at the point where MR = MC.  Do not confuse MC with AVC; there are different concepts and it is tricky to relate one to the other.  MC does equal AVC for the first unit produced (Q=1), but probably not for any other units.

In perfect competition, firms sell more and more Q until MR (marginal revenue) falls to the level of MC (marginal cost).  Stated another way, firms sell at the point where MR = MC.  Do not confuse MC with AVC; these are different concepts and it is tricky to relate one to the other.  When MC is greater than AVC, then AVC increases as output increases; when MC is less than AVC, then ACV decreases as output increases.

Master the above and you will both ace exams and be able to run a successful business.  Experienced business managers state that profitability is achieved primarily by reducing expenses.  This has certainly been true for Wal-Mart.  It is constantly driving costs down with its suppliers.  Remember: a penny saved is a penny earned.  Actually, due to taxes, saving a penny is sometimes worth more than a penny earned.

Master the above and you will both ace exams and be able to run a successful business.  Experienced business managers state that profitability is achieved primarily by reducing expenses.  This has certainly been true for Wal-Mart.  It is constantly driving costs down with its suppliers.  Remember: a penny saved is a penny earned.  Actually, due to taxes, saving a penny is sometimes worth more than a penny earned.

''Answer'':  Realize that the question is asking about the short run, so building a new factory or changing fixed costs is not possible.  There is not enough time.  Instead, the question is asking what can be done as a "quick fix" to the problem.  What is the problem?  The problem is that the sales price is LESS than the lowest average variable cost (AVC).  A firm is losing money when the price, or marginal revenue, is less than marginal cost.  A firm does not want to sell anything at less than marginal cost, because it loses money on it.   

''Answer'':  Realize that the question is asking about the short run, so building a new factory or changing fixed costs is not possible.  There is not enough time.  Instead, the question is asking what can be done as a "quick fix" to the problem.  What is the problem?  The problem is that the sales price is LESS than the lowest average variable cost (AVC).  A firm is losing money when the price, or marginal revenue, is less than marginal cost.  A firm does not want to sell anything at less than marginal cost, because it loses money on it.   

But how does marginal cost relate to AVC?  The relationship is tricky.  When Q=1, MC=AVC.  But that does not solve our problem above.  So let's read the question again carefully, which is so important in Economics.  The question says that the price (which is marginal revenue (MR)) is less than the MINIMUM AVC.  That means that MR is ALWAYS less than AVC, for all output Q.

Now let's read the question again carefully, which is so important in Economics.  The question says that the price (which is marginal revenue (MR)) is less than the MINIMUM AVC.  That means that MR is ALWAYS less than AVC, for all output Q.

So let's compare the profit or loss of the firm at two points:  when Q=0 (and thus AVC=0), and when Q>0 (and, as stated in the question, P<AVC, and thus MR<AVC).  The firm is losing money for every Q>0, because it is spending more on AVC than it is bringing in as price or marginal revenue.  The firm can reduce its loss by making Q=0.  In other words, the firm is better off by completely shutting down.

So let's compare the profit or loss of the firm at two points:  when Q=0 (and thus AVC=0), and when Q>0 (and, as stated in the question, P<AVC, and thus MR<AVC).  The firm is loses money for Q>0, because it is spending more on AVC than it is bringing in as price or marginal revenue.  The firm can reduce its loss by making Q=0.  In other words, the firm is better off by completely shutting down.

''Easy Question'': What is the firm's profit or loss when Q=0 in this problem?  This is an honors homework problem.

''Easy Question'': What is the firm's profit or loss when Q=0 in this problem?  This is an honors homework problem.