Editing Perfect competition (section)

==Results==
[[File:Perfect competition in the short run.svg|thumb|right|300px| In the short run, it is possible for an individual firm to make an [[economic profit]]. This situation is shown in this diagram, as the price or average revenue, denoted by <math>\text{P}</math>, is above the average cost denoted by <math>\text{C}</math> .]]

[[Image:Economics Perfect competition.svg|thumb|right|300px|However, in the long run, [[economic profit]] cannot be sustained. The arrival of new firms or expansion of existing firms (if returns to scale are constant) in the market causes the (horizontal) demand curve of each individual firm to shift downward, bringing down at the same time the price, the average revenue and marginal revenue curve. The outcome is that, in the long run, the firm will make only normal profit (zero economic profit). Its horizontal demand curve will touch its average total cost curve at its lowest point. (See [[cost curve]].)]]

In a perfectly competitive market, the [[demand curve]] facing a [[Theory of the firm|firm]] is perfectly [[demand elasticity|elastic]].

As mentioned above, the perfect competition model, if interpreted as applying also to short-period or very-short-period behaviour, is approximated only by markets of homogeneous products produced and purchased by very many sellers and buyers, usually organized markets for agricultural products or raw materials. In real-world markets, assumptions such as perfect information cannot be verified and are only approximated in organized double-auction markets where most agents wait and observe the behaviour of prices before deciding to exchange (but in the long-period interpretation perfect information is not necessary, the analysis only aims at determining the average around which market prices gravitate, and for gravitation to operate one does not need perfect information).

In the absence of externalities and public goods, perfectly competitive equilibria are Pareto-efficient, i.e. no improvement in the utility of a consumer is possible without a worsening of the utility of some other consumer. This is called the [[General equilibrium theory#First Fundamental Theorem of Welfare Economics|First Theorem of Welfare Economics]]. The basic reason is that no productive factor with a non-zero marginal product is left unutilized, and the units of each factor are so allocated as to yield the same indirect [[marginal utility]] in all uses, a basic efficiency condition (if this indirect marginal utility were higher in one use than in other ones, a Pareto improvement could be achieved by transferring a small amount of the factor to the use where it yields a higher marginal utility).

A simple proof assuming differentiable utility functions and production functions is the following. Let <math>w_j</math> be the 'price' (the rental) of a certain factor <math>j</math>, let <math>\text{MP}_{j1}</math> and <math>\text{MP}_{j2}</math> be its [[marginal product]] in the production of goods <math>1</math> and <math>2</math>, and let <math>p_1</math> and <math>p_2</math> be these goods' prices. In equilibrium these prices must equal the respective marginal costs <math>\text{MC}_1</math> and <math>\text{MC}_2</math>; remember that [[marginal cost]] equals factor 'price' divided by factor marginal productivity (because increasing the production of good by one very small unit through an increase of the employment of factor <math>j</math> requires increasing the factor employment by <math>\frac{1}{\text{MP}_{ji}}</math> and thus increasing the cost by <math>\frac{w_j}{\text{MP}_{ji}}</math>, and through the condition of cost minimization that marginal products must be proportional to factor 'prices' it can be shown that the cost increase is the same if the output increase is obtained by optimally varying all factors). Optimal factor employment by a price-taking firm requires equality of factor rental and factor marginal revenue product, <math>w_j=p_i \text{MP}_{ji}</math>, so we obtain <math>p_1=\text{MC}_{j1}=\frac{w_j}{\text{MP}_{j1}}</math>, <math>p_2=\text{MC}_{j2}=\frac{w_j}{\text{MP}_{j2}}</math>.

Now choose any consumer purchasing both goods, and measure his utility in such units that in equilibrium his marginal utility of money (the increase in utility due to the last unit of money spent on each good), <math>\frac{\text{MU}_1}{p_1}=\frac{\text{MU}_2}{p_2}</math>, is 1. Then <math>p_1=\text{MU}_1</math>, <math>p_2=\text{MU}_2</math>. The indirect marginal utility of the factor is the increase in the utility of our consumer achieved by an increase in the employment of the factor by one (very small) unit; this increase in utility through allocating the small increase in factor utilization to good <math>1</math> is <math>\text{MP}_{j1} \text{MU}_1=\text{MP}_{j1} p_1=w_j</math>, and through allocating it to good <math>2</math> it is <math>\text{MP}_{j2} \text{MU}_2=\text{MP}_{j2} p_2=w_j</math> again. With our choice of units the marginal utility of the amount of the factor consumed directly by the optimizing consumer is again w, so the amount supplied of the factor too satisfies the condition of optimal allocation.

Monopoly violates this optimal allocation condition, because in a monopolized industry market price is above marginal cost, and this means that factors are underutilized in the monopolized industry, they have a higher indirect marginal utility than in their uses in competitive industries. Of course, this theorem is considered irrelevant by economists who do not believe that general equilibrium theory correctly predicts the functioning of market economies; but it is given great importance by neoclassical economists and it is the theoretical reason given by them for combating monopolies and for antitrust legislation.

===Profit===
In contrast to a [[monopoly]] or [[oligopoly]], in perfect competition it is impossible for a firm to earn [[economic profit]] in the long run, which is to say that a firm cannot make any more money than is necessary to cover its economic costs. In order not to misinterpret this zero-long-run-profits thesis, it must be remembered that the term 'profit' is used in different ways: 
*Neoclassical theory defines profit as what is left of revenue after '''all''' costs have been subtracted; including normal interest on capital plus the normal excess over it required to cover risk, and normal salary for managerial activity. This means that profit is calculated after the actors are compensated for their opportunity costs.<ref name="pc">{{cite web|title=Microeconomics – Zero Profit Equilibrium |url=http://principles-of-economics-and-business.blogspot.com/2014/11/microeconomics-zero-profit-equilibrium.html|access-date=2014-12-05}}</ref>
*Classical economists on the contrary define profit as what is left after subtracting costs except interest and risk coverage. Thus, the classical approach does not account for opportunity costs.<ref name="pc" />
Thus, if one leaves aside risk coverage for simplicity, the neoclassical zero-long-run-profit thesis would be re-expressed in classical parlance as profits coinciding with interest in the long period (i.e. the [[rate of profit]] tending to coincide with the rate of interest). Profits in the classical meaning do not necessarily disappear in the long period but tend to [[normal profit]]. 
With this terminology, if a firm is earning abnormal profit in the short term, this will act as a trigger for other firms to enter the market. As other firms enter the market, the market supply curve will shift out, causing prices to fall. Existing firms will react to this lower price by adjusting their capital stock downward.<ref name="Frank 2008 351">Frank (2008) 351.</ref> This adjustment will cause their marginal cost to shift to the left causing the market supply curve to shift inward.<ref name="Frank 2008 351"/> However, the net effect of entry by new firms and adjustment by existing firms will be to shift the supply curve outward.<ref name="Frank 2008 351"/> The market price will be driven down until all firms are earning normal profit only.<ref>Profit equals (P − ATC) × Q.</ref>

It is important to note that perfect competition is a sufficient condition for allocative and productive efficiency, but it is not a necessary condition. Laboratory experiments in which participants have significant price setting power and little or no information about their counterparts consistently produce efficient results given the proper trading institutions.<ref>Smith (1987) 245.</ref>