3.7 Perfect Competition

Perfect competition has many small firms selling identical products with free entry and exit and full information. Each firm is a price taker: it sells all it wants at the market price and nothing above it, so the FIRM's demand curve is horizontal at that price, with P = MR = AR (while the MARKET demand curve still slopes down).

The signature graph is side-by-side: market supply and demand on the left set the equilibrium price, which carries over as the firm's horizontal demand/MR line on the right. The firm produces where MR = MC; profit or loss per unit is the vertical gap between price and ATC at that quantity, and the profit rectangle is that gap times quantity.

Short-run profits attract entry: market supply shifts right, price falls, and profits shrink until P = minimum ATC and economic profit is zero. Losses trigger exit and the reverse. In long-run equilibrium P = MR = MC = minimum ATC, giving both allocative efficiency (P = MC, the right quantity) and productive efficiency (production at lowest possible average cost).