Introduction

In this chapter, we put together consumers interested in buying a good and firms interested in selling the good. We start out by describing what we mean by perfect competition; this requires price-taking behavior by all parties, homogeneous goods, perfect information, and free entry and exit in the long run. We derive industry supply curves in the short run and in the long run. With consumers' actions aggregated into an industry demand curve, and firms' actions aggregated into an industry supply curve, we discuss excess demand and excess supply. Then we describe the competitive market equilibrium.

Next we turn to the welfare properties of the market equilibrium. We define producer's surplus for a single firm and producers' surplus for all the firms in the market. We will show how the competitive market equilibrium maximizes social surplus; that is, the sum of consumers' surplus and producers' surplus. Finally, we analyze the deadweight loss, or loss in social surplus, created by a per-unit tax on the good being sold in the market.

We use the idea of the market demand curve, developed in Chapter 4, and the idea of consumers' surplus, developed in Chapter 7. We also extend the welfare economics analysis of Chapter 7, but this time with an eye on both the consumers and the producers of the good.

Perfect Competition

As in Chapters 8 through 10, we are focusing on competitive firms. A firm is competitive if it takes prices as given; that is, beyond its control.