perfect-competitionUnder perfect competition, when price is below average total costs, firms are making losses. This will lead to firms exiting the market until price equals average total costs.
Why don’t the firms exit the market en masse such that supply will drop to 0 and the market will no longer exist?
My guess is that each firm is actually making various level of losses and since firms are price takers, this must mean that they have different cost structures so that the firms exiting are the ones that are making the largest losses first.
But under perfect competition, we also assume perfect information. Doesn’t this imply that firms will have access to the same technology and hence, the same cost curve?
Update:
Based on the comment of Adam Bailey, in the short run, firms can shutdown instead of exit the industry when they are making losses, where making losses mean their selling price is below the their average variable costs.
But if their selling price is below their minimum average costs, then in the long run, they will exit the industry.
Since perfect information for producers imply that they only have access to the same production technology and not the actual resources to acquire it, it is conceivable that although each producer is producing an identical product, each have very different cost structures.
Therefore, the only reason I can think of why producers won’t exit the industry en masse is because each is hoping that the more expensive producer will exit first.
Is this the logical conclusion implied by the perfect competition model?
My guess is that each firm is actually making various level of losses and since firms are price takers, this must mean that they have different cost structures so that the firms exiting are the ones that are making the largest losses first.
This is correct. It is the marginal firms that exit as profits fall.
If all firms are equally productive and have the same costs and profits, then all firms will exit if they are taking loses.
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