3.4.1 & 3.4.2 Efficiency & Perfect Competition

Question 1

Allocative efficiency

Answer 1

• 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)

Question 2

Productive efficiency

Answer 2

• when firms produce at the lowest point on the average cost curve.
• MC = AC
• All points on the PPF curve are productively efficient.

Question 3

Dynamic efficiency

Answer 3

• 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

Question 4

Example of dynamic efficiency

Answer 4

taking super normal profits and reinvesting into R&D

Question 5

Factors affecting short run factors

Answer 5

• demand
• interest rates
• past profitability.
  (Short run costs might be increased in order to cause long run costs to fall)

Question 6

Dynamic efficiency evaluation

Answer 6

• 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.

Question 7

X-inefficiency

Answer 7

• 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)

Question 8

Reason of X inefficiency

Answer 8

• organisational slack
• a waste in the production process
• poor management
• simply laziness

Question 9

Monopolies, x-inefficient

Answer 9

Monopolies tend to be x-inefficient, since they have little incentive to lower their average costs because of the lack of competition they face

Question 10

Free market efficiency

Answer 10

• Free markets are considered to be allocatively efficient.

Question 11

Perfect competition efficiency

Answer 11

• Allocative in short and long run
• Productive in short and long run

Question 12

Characteristics of perfect competition

Answer 12

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

Question 13

Significance of producing homogenous products

Answer 13

• 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

Question 14

Examples of perfect competition

Answer 14

• foreign currency exchange
• agricultural produce (rice)
• stock exchange

Question 15

Super normal profit graph

Question 16

What happens if a firm is producing super normal profit in perfect competition? w graph

Answer 16

• 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

Question 17

What happens if a firm is making a loss in perfect competition? w graph

Answer 17

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

Question 18

At what point on the curve do firms enter?

Answer 18

If TR > TC or P > ATC, the firm is profitable (supernormal profits)

Question 19

At what point on the curve do firms enter?

Answer 19

If TR > TC or P > ATC, the firm is profitable (supernormal profits)

Question 20

Break even price

Answer 20

If TR = TC or P = ATC the firm breaks even (normal profits)

Question 21

At what point on the curve do firms leave?

Answer 21

If TR < TC or P < ATC incurs a loss

Question 22

Why might firms change from profit max to sales max?

Answer 22

• to reduce excess supply
• to deter firms from entering the market

Question 23

Normal profits

Answer 23

just enough to keep the factors of production

Question 24

Why might a firm be making super normal profit in the long run?

Answer 24

• 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

Question 25

If firms are contestable, why likely produce at normal profit instead of super normal profits?

Answer 25

• they are allocatively efficient
• D = MC =AR
• Firms are making normal profit at the maket price & the firms output

Question 26

How has e-commerce made markets more competitive?

Answer 26

• 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

Question 27

Importance of super normal profit

Answer 27

• 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

Question 28

If a business is in a perfectly competitive market why might it keep producing?

Answer 28

• 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)

Question 29

Increase in rent graph

Question 30

Reason of X-inefficiency (poor management)

Answer 30

• poor management might mean not getting the cheapest possible prices on its supplies, employing too many workers

Question 31

Perfect competition graph explanation

Answer 31

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).

Question 32

Perfect competition short run profit graph

Answer 32

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.

Question 33

Perfect competition long run firm facing short term supernormal profits graph explanation

Answer 33

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.

Question 34

Perfect competition long run firm facing short term supernormal loss graph explanation

Answer 34

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.

Question 35

What makes a firm perfect competition?

Answer 35

TR is constant