Interactive Perfect Competition Diagram

Two-panel diagram showing industry market equilibrium and individual firm behaviour side by side. Explore how market price feeds directly into the firm, and how long-run entry and exit drives profit to zero. Built for AQA, Edexcel and OCR A Level Economics.

Diagram:Supply & Demand AD/AS PPF Monopoly Perfect Competition Labour Market Externalities Phillips Curve Trade & Tariffs Natural Monopoly Economy Dashboard MONIAC Domino Chains

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Demand (D1)

D1 shift+0

D2 shows the effect of a demand shift on P* and the firm's AR=MR line

Supply (S1)

S1 shift+0

S2 shows how a supply shock changes P* for all firms

Market outcome

Industry Q*

50.0

Market P*

£60.0

P* feeds directly into the firm as its horizontal AR=MR line.

Market P* = £60.0. Firm produces q* = 46.7 earning supernormal profit of £906. Long-run: new firms enter until P = min AC ≈ £36.6.

Perfect competition is the benchmark market structure: many firms selling identical products, with perfect information and no barriers to entry or exit. This two-panel tool puts the industry market next to an individual firm, so you can see how the market price becomes the firm’s demand curve and how entry and exit remove supernormal profit or losses in the long run.

How to use this tool

On the Market tab, use “D1 shift” and “S1 shift” to set the industry equilibrium. The market price P* is carried across to the firm panel as the horizontal AR=MR=D line.
Click “+ Add D2” or “+ Add S2” to add a second demand or supply curve and compare the new price P2* with the original. The firm panel shows the new AR=MR line and the output q2* the firm would choose.
On the Firm tab, use “MC base cost (£)” and “AC height” to change the firm’s costs, and tick “Show profit/loss area” to shade supernormal profit or the loss. The Firm outcome readout gives q*, AC at q*, profit per unit and total profit.
On the Long Run tab, click “Show long-run adjustment” to add the long-run price line at minimum AC and an explanation of the entry or exit that follows from the current position.

What to notice

The firm is a price taker: it can sell any quantity at the market price, so its demand curve is perfectly elastic and price equals average revenue and marginal revenue.
The firm maximises profit where MC = MR. Because MR equals price, this is also where price equals marginal cost, which is why perfect competition is allocatively efficient.
If price is above AC at q*, the firm makes supernormal profit (the green rectangle); if price is below AC, it makes a loss (the red rectangle). The area is (P − AC) × q.
Supernormal profit attracts new firms, so industry supply shifts right and the price falls until it equals minimum AC. Losses cause firms to leave, so supply shifts left and the price rises to minimum AC.
In long-run equilibrium every firm makes normal profit and produces at the lowest point of AC, so it is productively efficient as well as allocatively efficient.
The tool does not draw an average variable cost (AVC) curve. In theory a loss-making firm keeps producing in the short run as long as price covers AVC; below minimum AVC, the shutdown point, it stops producing.

Using it in the exam

Draw perfect competition as two side-by-side diagrams with the same price axis: the industry with D and S, and the firm with MC, AC and a horizontal AR = MR line at the market price. Label P*, Q*, q* and AC at q*, and shade the profit or loss area. Then use the diagram in a chain of analysis: a rise in market demand raises the price, so the firm’s AR = MR line moves up, it expands output to where MC = MR and earns supernormal profit; because there are no barriers to entry, new firms enter until the price falls back to minimum AC.

Evaluate: Perfect competition is a theoretical model and very few real markets meet all of its assumptions, although some agricultural and commodity markets come close. Because firms make only normal profit in the long run, they may have little to fund research and development, so the model can be weaker on dynamic efficiency than markets where firms earn supernormal profit. Each firm is also too small to gain large economies of scale, so a perfectly competitive market does not always give consumers the lowest possible prices.

Revise the theory

Revise the theory behind this tool in our Edexcel revision notes:

Practise drawing the static versions you will need in the exam:

Frequently asked questions

Why is the firm’s demand curve horizontal in perfect competition?

Each firm is so small relative to the market that its output has no effect on the market price, and its product is identical to every other firm’s. It can sell as much as it wants at the market price but nothing above it, because buyers would switch to rivals. Its demand curve is therefore perfectly elastic at the market price, and equal to AR and MR.

Why do firms make only normal profit in the long run?

Supernormal profit signals to firms outside the industry that they can earn more by entering. With no barriers to entry and perfect information, new firms join, industry supply increases and the market price falls. Entry continues until the price equals minimum average cost, at which point each firm earns only normal profit and there is no further incentive to enter.

When does a perfectly competitive firm shut down?

In the short run a firm should keep producing as long as price covers average variable cost, because it then makes some contribution to fixed costs that must be paid anyway. If price falls below minimum average variable cost, the shutdown point, it should stop producing. In the long run a firm leaves the industry if price stays below average total cost.