3.1.10 - Perfect Competition Flashcards
What is a defining characteristic of goods in perfect competition?
All goods are homogeneous (i.e., identical)
There is no branding, leading to no consumer preference between firms.
How does the number of buyers and sellers affect market price in perfect competition?
A large number of buyers and sellers means individual actions have no influence on market price
Each firm and buyer represents a small part of total supply and demand.
What is the significance of barriers to entry or exit in perfect competition?
There are no barriers to entry or exit, allowing firms to enter or leave freely
This occurs quickly and without cost.
What type of knowledge do firms and consumers have in perfect competition?
Firms and consumers have perfect knowledge of market conditions
They are aware of prices and activities of other market participants.
What do firms in perfect competition seek to maximize?
Firms seek to maximize profits by producing where MC=MR
MC = Marginal Cost, MR = Marginal Revenue.
What allows consumers to switch sellers in perfect competition?
Consumers can move freely from one seller to another without obstacles
This includes no transport costs preventing purchases from any firm.
In perfect competition, why do customers buy from firms charging the lowest price?
Customers always buy from firms charging the lowest price because all units are identical
This leads to price competition among firms.
What is a Price-Taker?
A price taker is a buyer or seller in a competitive market who has no control over the market price and must accept it as it is.
Why are all firms in Perfect Competition Price Takers?
Each firm accounts for only a tiny proportion of the total supply in the industry
Therefore, no firm can influence the market price through their supply decisions, meaning they have no control over the price they charge.
What happens if a firm tries to charge more than the market price in perfect competition?
- Consumers will switch to another firm
- This is because Consumers have perfect knowledge of market conditions, and there are no boundaries to consumption (e.g. transport costs)
What will happen to a firm that charges even a penny above the market price?
It would lose all its customers and sell none of its output
This highlights the competitive nature of the market.
What is the implication of being a price taker for a firm’s demand curve?
The firm’s demand curve will be perfectly elastic
This means the firm can sell as much as it wishes at the market price.
What are the three consequences of Perfect Competition for firms due to their elastic demand curve in this market structure?
1) Firms will not charge higher prices than the market rate, for if they do their demand will drop to zero
2) Firms will not charge lower prices than the market rate, since it would not be selling any more at a lower price.
3) Firms can sell as much quantity as they want at the Market Rate, since their individual actions will not change this rate.
How is Market Price in Perfect Competition determined?
By the Demand and Supply diagrams for the Industry as a whole
What does the individual firm’s demand curve represent in perfect competition?
It is also its AR and MR curve.
In perfect competition, what must be true about a firm’s MR?
MR is always equal to the price level.
What is the relationship between price, MR, and AR for any firm in perfect competition?
Price = MR = AR.
What does it imply if MR is constant in a perfectly competitive firm?
Total revenue must increase at a constant rate.
What shape does the total revenue curve of a firm under perfect competition take?
It is a straight upward-sloping curve.
Fill in the blank: In perfect competition, the demand curve, marginal revenue curve, and average revenue curve are all _______.
[identical]
What is the profit-maximising condition for a firm?
A profit-maximising firm will produce at the level of output where MC=MR.
In a perfectly competitive firm, what determines price?
Price is determined in the market where industry demand equals industry supply.
What is the formula for total revenue?
Total revenue is calculated as p x q.
What indicates that a firm is making a profit per unit?
The revenue per unit (AR) is greater than the cost per unit (AC).
What does the vertical distance between the AR curve and the AC curve represent?
It shows the profit earned per unit of output.
How is total profit earned by the firm calculated?
Total profit is equal to AB x q, where AB is the profit per unit.
What does the shaded area ABCP represent in the diagram?
It shows the total profit earned by the firm.
What does the area CBqO represent?
It shows the total costs of the firm.
What is the significance of producing at the level where MC=MR? (2)
- It is the profit maximising level of output
- It is also the loss-minimising level of output
True or False: Perfectly competitive firms always make supernormal profits in the short run.
False.
What happens if there is a fall in market demand for a perfectly competitive firm?
The firm may incur losses as the market price \of the product decreases.
What does the total loss of the firm equal on this diagram?
Total loss is equal to AB x q, where AB is the loss per unit.
What does the area PBqO represent?
It shows the total revenue made by the firm.
What does the area CAqO represent?
It shows the total costs of the firm.
Summary of Firms in Perfect Competition in the Short Run
- Firms in perfect competition can make Supernormal Profits in the short run.
- Firms in Perfect Competition can also make losses in the short run
- Output will always remain at MC=MR, but whether the firm makes a profit or a loss is determined by the price established by the market.
What is the condition for firms to earn supernormal profits in the short run?
AR > AC
What happens to supernormal profits in the long run in a perfectly competitive market?
No supernormal profits can be earned
What attracts new firms into an industry when existing firms are making supernormal profits?
The potential for earning supernormal profits
What is the assumption about Perfect Competition that allows new firms to enter the industry easily in the long run?
There are no barriers to entry
What happens if Firms in Perfect Competition are making Super Normal Profits in the Long Run? (3)
- New Firms will be attracted into the industry, via super normal profits and a lack of barriers to entry. Thus, industry supply curve shifts right, causing market price to fall.
- Due to market price falling, Super Normal Profits decline, as the gap between AR (Price) and AC shrinks.
- This process repeats until all supernormal profits have been eliminated, and firms in the market only earn normal profits, causing new firms to stop entering the industry.
Fill in the blank: In the long-run equilibrium of a perfectly competitive market, firms earn _______.
normal profits
Can perfectly competitive firms make losses in the short run?
Yes, perfectly competitive firms can make losses in the short run.
Losses occur when average cost (AC) exceeds average revenue (AR).
What happens to firms in an industry making losses in the long run?
Firms will leave the industry.
This occurs because there are no barriers to exit.
What is the relationship between average cost (AC) and average revenue (AR) when firms are making losses?
AC > AR.
This indicates that firms are not covering their costs.
What occurs to market supply and price in perfect competition when firms exit an industry?
Total industry supply will fall and thus market price will increase.
This is a result of reduced competition and supply.
What is the result when all losses have been eliminated in a perfectly competitive market?
Firms will earn only normal profits.
Normal profits occur when AC equals AR.
What is the condition for firms to stop leaving the industry?
Firms stop leaving when they are earning only normal profits.
This occurs when AC=AR.
What is long-run equilibrium in a perfectly competitive market?
Long-run equilibrium is when no losses are made (i.e. AC=AR).
In this state, firms are operating efficiently.
