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At what price will there be neither economic profit to attract new firms into the market nor
economic loss to drive firms out of the market? At minimum Average Total Cost. In the long run,
the price will be equal to minimum Average Total Cost, and the firms will be earning zero
economic profit (a normal profit). A graph illustrating perfect competition in the long run is
included in an appendix at the end of this chapter.
Perfect Competition and Economic Efficiency
The basic economic problem is scarcity. The basic goal in dealing with the problem of scarcity is
to produce as much consumer satisfaction as possible with the limited resources available. To
achieve this goal, society must use its limited resources as efficiently as possible.
The concept of the economically efficient level of an activity was introduced in Chapter 1 and was
further explained in Chapter 18. In Chapters 1 and 18, we saw that the optimal (ideal, most
efficient) level of an activity occurs where the marginal benefit and the marginal cost of the activity
are equal. In this chapter, and for the rest of the textbook, we will refer to this economic efficiency
rule with slightly altered terminology.
Economic efficiency rule – produce the quantity of output where marginal social benefit equals
marginal social cost.
Marginal social benefit (MSB) is the value (benefit) to society of the marginal unit of output. If
there is an external benefit (see Chapter 27), marginal social benefit will be different than
marginal private benefit. Assuming no external benefits, marginal social benefit is the same as
marginal private benefit and is measured by market price.
Marginal social cost (MSC) is the cost to society of producing the marginal unit of output. If there
is an external cost (see Chapter 27), marginal social cost will be different than marginal private
cost. Assuming no external costs, marginal social cost is the same as marginal private cost and is
measured by marginal cost.
Thus, if there are no externalities, the ideal (economically efficient) quantity of output occurs
where price equals marginal cost.
Perfect competition is the ideal (most efficient) market structure because it results in the quantity
of output where price equals marginal cost and thus (assuming no externalities) where marginal
social benefit equals marginal social cost. Referring back to Example 6C, at the profit-maximizing
quantity of six units, price ($10) equals marginal cost ($10), and thus MSB equals MSC.
Perfect Competition’s Happy Coincidence
A perfect competitor, like any other business firm, has a chief goal of profit-maximization. To
achieve this goal, a perfect competitor will produce according to the profit-maximization rule
(produce the quantity of output where marginal revenue equals marginal cost). By a happy
coincidence, the profit-maximizing quantity of output is also the economically efficient quantity of
output (where price equals marginal cost and thus where MSB equals MSC).
So the goal of the firm (profit-maximization) and the goal of society (economic efficiency) are both
reached at the same quantity of output. This is why perfect competition is the ideal market
structure.
Perfect Competition and Individual Freedom
Another advantage of perfect competition is that perfect competition contributes to individual
freedom. In a perfectly competitive market, production and distribution decisions can be made by
individuals, not by central authority, thus maximizing individual freedom. Because the goal of the
firm (profit-maximization) and the goal of society (economic efficiency) are both reached at the
same quantity of output, society can leave perfect competitors alone, free to pursue self-interest.
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