2.11b Perfect Competition

Question 1

What is specific about perfect competition DIGs?

Answer 1

There are 2!
1 representing the market
1 representing the firm

Question 2

Why are there two DIGs to represent perfect competition?

Answer 2

1 representing the market
1 representing the firm
–> Because the firm takes the price from the market

Question 3

Show a perfectly competitive firm making “abnormal profit”?

Answer 3

The firm makes abnormal profit when P is greater than SRAC
–> AC has to be under the AR=MR curve for there to be an abnormal profit

Question 4

Show a perfectly competitive firm making “normal profit”?

Answer 4

The firm makes a normal profit when P = AC

Question 5

Show a perfectly competitive firm making “loss profit”?

Answer 5

The firm makes a loss profit when the P is lower than the SRAC

Question 6

Why can perfectly competitive firms ONLY make normal profit in the long run?

Answer 6

–> Lets assume a firm makes abnormal profit in the SR. Firms would see there is profit to be made and enter the market (no barriers to entry in a perfectly competitive market). Therefore the supply increases, and as demand stays the same, the price must fall
–> Firm no longer able to make abnormal profit, and is now making normal profit
–> no longer any interest for new firms to enter the market

Question 7

What types of profit can perfectly competitive firms make in the short run, but NOT in the long run?

Answer 7

• Loss profit
• Abnormal profit

Question 8

When is a firm allocatively efficient?

Answer 8

A firm is allocatively efficient when MC = AR

Allocative efficiency means that it is not possible to reallocate resources to make someone better off without making someone else worse off.

Question 9

What does allocative efficiency mean?

Answer 9

Allocative efficiency means that it is not possible to reallocate resources to make someone better off without making someone else worse off.