Cost Structures & Perfect Competition

Cost structures are the same throughout the four market stuctures.

• Because of the law of increasing costs and the law of diminishing marginal returns, as we use variable resources, such as labor, with fixed resources, such as capital, our marginal product decreases because of the limitations of our fixed resources.
• Total product will increase at a decreasing rate because of the law of diminishing marginal returns. So too will marginal product decrease at some point because of the limitations of our fixed resources which we cannot change in the short run.
• Total costs will at some point increase at an increasing rate because of the law of increasing costs. Marginal costs will also increase at some level of production, all because of the law of increasing costs.
• Because perfectly competitive industries are easy to enter, they face the prospect of falling prices when they are making economic profits. People outside the industry can easily enter the market when they see PCs making profits, thereby increasing supply and driving down the price.
• Perfect competitors cannot make economic profits in the long run because of ease of entry. Economic profits are equal to the profits that the firm could make in their next best alternative business opportunity.
• Perfect competitors can make a normal profit in the long run equivalent to the profit that could be made in the next best alternative business opportunity.
• In the long run, all costs are variable, meaning that they change as output changes.
• The short run is actually defined by whether one fixed cost exists. For example, if rent is the only fixed cost for a business, then the length of the short run is what’s left on the rent lease.
• Marginals and averages of cost and product relate to each other in a specific way. For example, if marginal cost is or marginal product is above average costs and average product, then the average will ascend. If marginal cost and marginal product are below average costs and average product then they will descend. Therefore, marginal cost strikes average total cost at its low point. Marginal product strikes average product at its peak.

For a more detailed explanation of Perfect Competition and cost structures, try this Reffonomics interactive activity. Also, see the Reffonomics lesson on cost curves.