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Beat The Market An Interactive Microeconomics Game  
TEACH EXAMPLES OF PERFECT
COMPETITION USING A SIMULATION
Beat The Market Online A Microeconomics Simulation
USE TO ILLUSTRATE PERFECT COMPETITION MARKET BEHAVIOR

There is an extensive and growing literature on the pedagogical effectiveness of simulation games in education (see Lean, Moizer, and Towler, 2006; Simkins, 1999; Motahar, 1994). The purpose of this note is to explain and illustrate how an economics simulation game can be used as an example and application of the perfect competition market to help in the teaching and learning of this market. A comprehensive guide on how to incorporate simulation games in business education at the college level is given by Gentry, et. Al. (1990).

Use in Standard Classroom or for Experimental Economics

A perfect competition simulation can be used as an example in the standard economics classroom or for experimental economics. Economic experiments using perfect competition simulations can create real-world incentives that may be used in the teaching and learning of economics to help students better understand why markets and other exchange systems work the way they do. A detailed explanation of experimental economics is given by Roth (1995).

An online computerized economic simulation game called “Beat the Market” is used to simulate several different examples of the Perfect Competition market (see a brief description of the simulation game at the AEA website. This simulation is designed to put students inside the theoretical world of perfect competition as described in the standard economics textbook.  Through the simulation, students participate directly in the market by managing a simulated firm and making decisions on price and production to maximize profits. 

Assumptions of Perfect Competition Simulation Game Example

All the example simulations follow the basic theoretical assumptions of the perfect competition market structure and include:

  1. A very large number of firms, at least 1000.
  2. Small firm size, starting market share of each firm is less than 1%.
  3. Easy entry and exit, based on economic versus normal profits.
  4. Identical products, differentiation is not possible.
  5. Full information is given to all market participants
Options in Simulating the Perfect Competition Market

In the example simulations, the instructor may select different environments within the context of perfect competition, including:

  1. Short-run versus long-run
  2. Changing events (random exogenous shocks)
  3. Macroeconomic environment (stable, growth, cyclical)

Two simulation game examples will be illustrated, including one short-run and one long-run simulation. The example simulations illustrated here will not have any random events and will hold the macroeconomic environment constant. (But the software does allow these variables, options 2 and 3 above, to be included at the discretion of the instructor.)

Short-run Perfect Competition Game Example Simulation

The short-run simulations do not allow students to change the plant size of their firm, but firms will still enter or exit the market if accounting profits differ from normal profit levels in the simulated perfect competition market.

Controllable Decisions in the Short-run Perfect Competition Simulation Game Example
  1. Firm Price
  2. Firm Production
Simulation Performance in Short-run Example

At the start, the market is not in equilibrium and has the following characteristics.

Quarter

Number of Firms

Market Price

Market Demand

Market Supply

Average Accounting Profit

0

1000

$75.11

5,087,000

4,100,000

$119,522

Note that normal profits in this market are $100,000 and the average market profit is $119,522.

Students make decisions for their firms based on their own firm characteristics. In this market example, firms start with an excess demand.  Students are given information on their firm costs and revenues, including the market price and marginal costs.  The knowledgeable students (and the numerous computer managed firms) begin by raising their prices to equal the higher market price that is reported in the game and increasing the quantity supplied.   In perfect competition it is critical that the firm set its price equal to the market price! No matter the decisions of any student managed firm, the overall behavior of the market is not influenced by any one student, since each firm is very small in size relative to the market.  In quarter 1 in this example, average firm accounting profits increase, but through time the following expected results occur.

Short-run Simulation Results (Normal Profits $100,000)

Quarter

Number Firms

Market Price

Market Demand

Market Supply

Average Accounting Profit

1

1000

$80.21

3,312,800

4,810,400

$147,255

2

1089

$69.33

7,088,337

5,037,337

$106,130

3

1138

$75.35

5,006,078

5,387,690

$128,677

4

1276

$73.63

5,602,769

5,999,369

$122,184

5

1409

$72.07

6,142,749

6,591,372

$116,330

6

1529

$70.49

6,688,463

7,108,092

$110,436

7

1573

$69.16

7,146,883

7,274,574

$105,503

8

1590

$68.79

7,274,257

7,343,097

$104,135

9

1631

$68.14

7,502,238

7,508,798

$101,069

10

1631

$68.00

7,519,179

7,519,323

$100,147

After quarter 1, new firms entered the market because accounting profits exceeded normal profit levels of $100,000 in this example. The number of firms increased from 1000 in quarter 1 to 1631 in quarters 9 and 10.  No additional firms entered in quarter 10 because accounting profits were close to normal levels.  The decrease in accounting profits occurred because the market price declined as new firms entered and the markets supply increased.  The market stabilized after ten quarters because economic profits were at, or close to, zero; and market demand was close to market supply.

Long-run Perfect Competititon Simulation Example

The long-run simulation example allows students to change the plant size of their firm and take advantage of economies of scale.  Both economies and diseconomies of scale exist in the simulation. Students are given information on how the average variable costs change in the simulation with increases in plant size.  But again, as required in the model, firms will enter or exit the perfect competition market until economic profits return to zero.  

Controllable Student Decisions in Long-run Simulation Example

In this example, plant size is added as a third controllable student decision, and now includes:

  1. Firm price
  2. Firm production
  3. Firm plant size
Simulation Performance in Long-run Example

At the start, the market is not in equilibrium and has the following characteristics.

Quarter

Number of Firms

Average Plant Size

Market Price

Market Demand

Market Supply

Average Accounting Profit

0

1000

6.0

$75.11

5,087,000

4,100,000

$119,522

Note that the starting characteristics of the market are set to be the same as in the short-run example.  Normal profits are again $100,000. In this way comparisons can be made more directly between the two simulation examples.  The major difference in the long-run example is that plant size may now be changed.  As in the previous simulation example, all firms start with an excess demand, and their accounting profits are initially $119, 522, which are greater than normal profits. Given this starting scenario, students again begin by raising their prices equal to the higher market price and increasing the quantity supplied.  But this time, plant size also increases as students take advantage of economies of scale that is built into this simulation example. Firm profits increase initially, but through time the following expected results occur.

Long-run Simulation Results (Normal Profits $100,000)

Quarter

Number Firms

Average Plant Size

Market Price

Market Demand

Market Supply

Average Accounting Profit

1

1000

6.0

$80.21

3,312,800

4,810,400

$147,698

2

1091

7.3

$69.19

7,136,552

5,562,573

$121,962

3

1182

9.4

$73.77

5,554,252

6,755,603

$161,307

4

1294

11.5

$68.98

7,208,857

8.176,980

$161,909

5

1440

13.6

$66.20

8,163,942

10,063,224

$ 164,939

6

1573

15.4

$61.58

9,742,238

12,100,224

$ 148,376

7

1765

16.3

$57.11

11,258,060

14,422,786

$122,255

8

1963

16.9

$52.29

12,879,290

16,185,033

$90,629

10

1742

15.6

$46.98

14,648,039

13,412,790

$62,010

12

1397

14.5

$50.89

13,347,451

10,193,420

$86,234

14

1351

14.0

$57.10

11,085,696

10,677,696

$99,251

16

1351

14.0

$57.62

11,001,184

11,077,696

$100,110

These results had a number of similarities to the short-run example, but also some major differences. As in the short-run example, firms entered the market after quarter 1 because accounting profits exceeded normal profit levels of $100,000.  But this time firms increased plant size as the number of firms entered. The increase in plant size occurred because economies of scale existed in the beginning of the simulation game. The number of firms increased causing price to drop and profits to fall until quarter 8, where average profits of $90,629 dropped below normal profit levels.  Firms in the simulation expanded too quickly, realizing diseconomies of scale; and more entered the market than could be supported in the long-run. At this point (after quarter 8), firms began exiting the market and decreasing plant size, causing marke supply to decrease and market prices to rise. In quarter 12, profits began to increase and firms stopped exiting the market when profits returned to normal levels (approximately $100,000)  in quarter 16.  The market reached equilibrium because economic profits were at, or close to, zero; and market demand was close to market supply.

Comparing the long-run to the short-run simulation example there were several important differences.

  1. Plant size increased in the long-run example simulation from 6.0 to 14, since it was a controllable decision of the firm and there were economies of scale.
  2. A plant size greater than 14 could not be sustained for the long-run, since diseconomies of scale existed for larger plants.
  3. Market price in the long-run was bid down much lower than in the short-run example because firms were able to lower their average costs due to economies of scale.   
  4. Even though firms were able to reduce costs through economies of scale, they were not able to maintain profits above normal levels in the long-run. Firms entered and exited the market until profits returned to normal levels.
  5. Comparing the final long-run equilibrium in perfect competition to the monopolistic competition example simulation, market price was lower and quantity supplied was higher.

These simulation example results are all consistent with the economic theory of market behavior in perfect competition versus monopolistic competition.

Concluding Remarks

From an educational point of view, the benefit of a simulation game example is that students will have an “opportunity” to learn by their own observations and experience.  In these simulation examples, student participants would observe and experience that their pricing decisions are controlled by the market. They would “experience” that in the simulation they would have to lower their firm’s price to the market price to be competitive as new firms entered the market. In the long-run simulation example, they would see the impact of changing plant size.  They would observe that the successful firms would take advantage of economies of scale, but would also be careful not to incur diseconomies of scale in the long-run.  Students would see the benefits of economies of scale in reducing costs and increasing profits, but experience that economic profits cannot be maintained in the long-run.  They would observe, first hand, that their accounting profits will inevitably decline and move closer to normal profits.  While participating in the simulation, students would experience the same dilemmas and frustrations that firm owners face in the real world.  This experience provides students another opportunity to learn (as a supplement to the lecture and readings) the economic messages of "Perfect Competition".

References on Active Learning and Experimental Economics

Gentry, J., ed., (1990), Guide to Business Gaming and Experiential Learning, ABSEL, Nichols/GP Publishing, East Brunswick.

Lean, J., Moizer, M., Towler, C. A. (2006). Active Learning in Higher Education, Journal of Simulation and games, 7(3), 227-242.

Simkins, S.P. (1999), Promoting active-student learning using the World Wide Web in economics courses, Journal of Economic Education, 30(Summer), 278-291.

Motahar, Eshragh (1994), Teaching modeling and simulations in economics: A Pleasant Surprise, Journal of Economics Education, 25 (4), 335-342.

Roth, A.E. (1995), Introduction to experimental economics, in Kagel, J.H. and Roth, A.E. (eds.), The Handbook of Experimental Economics. Princeton: Princeton University Press, pp. 3-109.