3.4.1 & 3.4.2 Efficiency & Perfect Competition Flashcards
Allocative efficiency
- producing what is demanded by consumers at a price that reflect the marginal cost of supply
- This maximises utility (consumer surplus is maximised)
- exists at P = MC (consumers pay for the value of the marginal utility they derive from consuming g/s)
Productive efficiency
- when firms produce at the lowest point on the average cost curve.
- MC = AC
- All points on the PPF curve are productively efficient.
Dynamic efficiency
- when business supplying a market successful meet the consumers changing needs and wants over time)
- all resources are allocated efficiently over time, & the rate of innovation is at the optimum level = falling LRAC
Example of dynamic efficiency
taking super normal profits and reinvesting into R&D
Factors affecting short run factors
- demand
- interest rates
- past profitability.
(Short run costs might be increased in order to cause long run costs to fall)
Dynamic efficiency evaluation
- consider the long time lag between making an investment and having falling average costs
- consider how factors change in the long run
- also some firms will face a trade-off between giving their shareholders dividends and making an investment.
X-inefficiency
- a lack of real competition may give a monopolist less of an incentive to invest in new ideas or consider consumer welfare
- when producing within the AC boundary (a point above or within the ac curve)
Reason of X inefficiency
- organisational slack
- a waste in the production process
- poor management
- simply laziness
Monopolies, x-inefficient
Monopolies tend to be x-inefficient, since they have little incentive to lower their average costs because of the lack of competition they face
Free market efficiency
- Free markets are considered to be allocatively efficient.
Perfect competition efficiency
- Allocative in short and long run
- Productive in short and long run
Characteristics of perfect competition
1) Freedom of entry and exit (firms can enter/leave where profit is)
2) All firms produce an identical/homogeneous product.
3) All firms are price takers, so the firm’s demand curve is perfectly elastic
4) There is perfect information and knowledge
Significance of producing homogenous products
- seller can’t influence market due to selling a unique product
- market price won’t change since other producers selling exactly the same thing
- can’t have economies of scale
Examples of perfect competition
- foreign currency exchange
- agricultural produce (rice)
- stock exchange
Super normal profit graph
What happens if a firm is producing super normal profit in perfect competition? w graph
- if supernormal profits are made, new firms will be attracted to the industry and join
- this will cause the supply curve to shift out and prices to fall
- thus the firm will only be making normal profit
What happens if a firm is making a loss in perfect competition? w graph
If firms are making a loss then firms will leave the industry causing supply to shift to the left and price to rise
- firms will now be making normal profit
At what point on the curve do firms enter?
If TR > TC or P > ATC, the firm is profitable (supernormal profits)
At what point on the curve do firms enter?
If TR > TC or P > ATC, the firm is profitable (supernormal profits)
Break even price
If TR = TC or P = ATC the firm breaks even (normal profits)
At what point on the curve do firms leave?
If TR < TC or P < ATC incurs a loss
Why might firms change from profit max to sales max?
- to reduce excess supply
- to deter firms from entering the market
Normal profits
just enough to keep the factors of production
Why might a firm be making super normal profit in the long run?
- the market decides the price, the firm produces at this price in the short run
- here the MR may be bigger than MC. If the price is higher than the AC = super normal profit
- in the long run, they’ll produce where profit is maximising MC=MR
If firms are contestable, why likely produce at normal profit instead of super normal profits?
- they are allocatively efficient
- D = MC =AR
- Firms are making normal profit at the maket price & the firms output
How has e-commerce made markets more competitive?
- lower barriers to entry, less imperfect information and more homogenous
- E.g amazon, tripadvisor, google
- However, some brands produced /9e.g amazon, spotify have not made the markets more competitive
- Amazon has become a huge scale. Although information is there, there is bounded rationality since the information is too much
- Consumers might choose the best option or have brand loyalty
Importance of super normal profit
- These profits might be used for R&D (e.g medicine
- There’s a loss of dynamic efficiency (low miniment efficient scale)
- some might prefer a few big firms that improves (better products) using their super profit rather than lots of firms
- e.g music (we implement copyright for artists so they are willing to create more music
If a business is in a perfectly competitive market why might it keep producing?
- increasing training to reduce AVC
- if the firms has the price above its variable costs it can keep training in the SR (reducing its loss)
Increase in rent graph
Reason of X-inefficiency (poor management)
- poor management might mean not getting the cheapest possible prices on its supplies, employing too many workers
Perfect competition graph explanation
Perfect competition has a large number of suppliers in the market. A firm can expand or reduce output without influencing price. The price is determined by the market because the individual firm is too small to influence price and is a price-taker.
each extra item sold will receive the same price for each additional unit and, therefore, marginal revenue will be the same as average revenue
In perfect competition, we assume firms are profit maximisers and produce where marginal cost is equal to marginal revenue (MC=MR). Perfectly competitive firms can make supernormal profits in the short run. In this diagram the horizontal demand/average revenue curve is shown to be above the average total cost at the point where MC=MR (point A). At Q1 the firm charges P1, but faces only average costs of P2. The firm will make supernormal profits shown by the shaded area (P1P2AB).
Perfect competition short run profit graph
The diagram below shows short-run firm-making losses. The firm is profit maximising where MR=MC. The price charged is P2 and average costs P1. This brings about losses equal to P1P2CD.
Perfect competition long run firm facing short term supernormal profits graph explanation
If a firm is making losses in the long run, some firms would leave the industry as there are no barriers to exit. As a result, total supply falls from S1 to S2. At S1, the firm makes a loss. At S2, the demand shifts upwards as firms leave the markets leading to normal profits.
Perfect competition long run firm facing short term supernormal loss graph explanation
In the long run, competition ensures that equilibrium occurs where firms make neither supernormal profits nor losses. Average costs will equal average revenue and the firms make normal profit.
What makes a firm perfect competition?
TR is constant
