3.4.2, 3.4.3 Competition

Question 1

Key features of perfect competition

Answer 1

1) Homogenous goods (identical)
2) Price takers (firms)
3) Infinite buyers and sellers (hypothetically)
4) Perfect knowledge - to make informed decisions
5) No barriers to entry/exit

Question 2

Perfect competition in the short run

Answer 2

Firms are earning supernormal/subnormal profit (all firms just charge the same market price)

Question 3

Perfect competition in the long run (SR supernormal)

Answer 3

1. Supernormal profits attract new firms (incentive)
2. Firms enter the market easily (supply increases)
3. Market price falls until excess profits have been competed away (normal profits made)

Question 4

Perfect competition in the long run (SR subnormal)

Answer 4

1. Subnormal profits made, causing firms to leave the market (supply decreases)
2. Market price rises so firms still in the market earn normal profit

Question 5

When are firms likely to leave the market? (shutdown condition)

Answer 5

If price (AR/MR) is less than average variable costs

Question 6

When might firms be indifferent to leave or stay in the market? (shutdown condition)

Answer 6

If price (AR/MR) is equal to average variable costs (not covering avg. fixed costs) - as firms leave, the market price would rise eventually

Question 7

When are firms likely to stay in the market? (shutdown condition)

Answer 7

If price (AR/MR) is higher than average variable costs

Question 8

Perfect competition and efficiencies

Answer 8

1. Usually leads to allocative efficiency
2. Leads to productive efficiency
3. Doesn’t lead to dynamic efficiency
4. Leads to static efficiency