3.4.2 - Perefect competion Flashcards
Characteristics of perfect competition
- Many small buyers and sellers
- No barriers to entry or exit
- Homogenous goods
- Perfect information : buyers and sellers possess perfect knowledge of prices
- We assume that firms are profit maximisers
Blurt everything you know about Homogenous goods
All goods/services are the same and therefore firms within in perfectly competitive markets cannot gain price making powers through unique goods/services.
- Which cause firms to price takers
Blurt everything you know about many buyers and sellers
There are many buyers within the market and many small firms selling the good/service. Therefore, consumers have lots of choice, meaning that if one firm increases their prices, the consumer will simply shop at another firm
Blurt everything you know about No barriers to entry or exit
Firms can easily enter and exit the market whenever they want. This means that any supernormal profit that can be gained from the market will attract new entrants, thus increasing supply, leading to a decrease in price and therefore the removal of the supernormal profits.
Blurt everything you know about Perfect information
Buyers and sellers have perfect levels of information. This means that buyers and sellers know when another firm has changed their price level.
Blurt everything you know about Firms profit maximise
Firms operate at the profit maximising point where marginal cost is equal to marginal revenue.
Draw the diagram for perfect competition when there’s supernormal profit in the market in the SR and explain the diagram
- The price is set by the market (draw your S&D diagram first)
- ## Since firms are price takers in a perfectly competitive market we draw this price to the individual firm diagram (cost and rev diagram)
Draw the diagram for perfect competition when there’s supernormal profit in the market in the LR and explain the diagram
- Firms are incentivised by supernormal profit to enter the market. There are no barriers to entry so they can easily enter the market. This increases supply from S to S1. This decreases price from Pe to P1, so price = lowest point along AC and all supernormal profit has been competed away. Only normal profit can be made in the long run
Draw the diagram for perfect competition when there’s subnormal profit in the market in the SR and explain the diagram
Draw the diagram for perfect competition when there’s subnormal profit in the market in the LR and explain the diagram
If firms are making a short run loss, they will leave the market and this is easy to do because there is no barriers to exit.
As firms leave the market, supply decrease and prices will increase back up, until normal profit can be made.
At this point, firms will be covering their opportunity cost - so they’ll no reason to leave the market anymore. Which means we’ve reached our long run equilibrium - where firms are making normal profit!
- Only normal profits can be made in the long run.
Draw the MR and AR curve for a perfectly competitive market and explain why it looks like this
- Firms are price takers, so demand sets the price
- Demand will determine their revenue as Q sold is due to demand hence why AR=D
- MR = D also as the extra unit sold is due to demand
- Note that this diagram also looks like a perfectly elastic demand curve this is because consumers have perfect knowledge on price so if price increases even by a little bit, demand instantly drops to 0 (exactly what happens in a perfectly elastic diagram).
Are firms allocatively efficient in the long run ?
- Allocative efficiency is when P=MC
- Films are being allocatively efficient in the long and short run as P=MC
- This because Firms are price takers - taking the market price where supply meets demand. Therefore resources are following consumer preferences.
Are firms productively efficient in the long run ?
- productive efficiency is when MC=AC
- Yes they are because firms are operating at the lowest point on their average cost curve
- The high levels of competition and the fact that firms are price takers means that it is essential for firms to keep costs to a minimum. they would go out of business if they were not producing at the lowest cost possible because other firms would be and would force them out of the market. This means firms are fully exploiting any economies of scale in this market to keep prices low.
Are firms x - efficient in the long run ?
- X-efficiency is when firms are minimising waste.
- In this case yes firms are being x-efficient
- If a firm is productively efficient it must be x-efficient as well – producing on AC curve). Firms have to operate at the lowest attainable average cost as they would go out of business otherwise. This is to minimise waste and cost.
Are firms dynamically efficient in the long run ?
- Dynamic efficiency is when firms innovate new technology, and invest in R&D.
- In this case firms are dynamically inefficient as they do not make supernormal profits in the long run so can not reinvest to become more innovative to provide better choice or more efficient production methods.
Eval point : They make SNP in the short run so they may uses these profits to re invest.
