3.4.2: Perfect Competition

Question 1

What is perfect competition?

Answer 1

A market where there is a high degree of competition (opposite to a monopoly).

Question 2

What are the characteristics of perfect competition?

Answer 2

-Many buyers & sellers (so no single firm can influence the market).
-Homogeneous products (identical, like selling water).
-Perfect information (all market participants have full knowledge of product characteristics).
-No barriers of entry/exit (all firms have access to factors of production).

Question 3

Short Run Perfect Competition Graph:

Answer 3

Question 4

Long Run Perfect Competition Graph:

Answer 4

Question 5

How is price determined in perfect competition?

Answer 5

Firms are price takers.

Question 6

What is the difference in profit between short term and long term?

Answer 6

In short term, supernormal profit can be made. In long term, only normal profit can be made.

Question 7

(Perfect competition) In the short term, are firms:
-Allocatively efficient?
-Productively efficient?
-Dynamically efficient?

Answer 7

-Yes: P = MC.
-No: firms aren’t producing at the lowest average costs.
-Yes: supernormal profit can be used for investment.

Question 8

(Perfect competition) In the long term, are firms:
-Allocatively efficient?
-Productively efficient?
-Dynamically efficient?

Answer 8

-Yes: P = MC.
-Yes: firms are producing at the lowest average costs.
-No: normal profit alone can’t be used for investment.

Question 9

(Perfect competition) Why are firms unable to make supernormal profit in the long run?

Answer 9

The short term supernormal profits incentivise firms to join the market, which is easy due to a lack of barriers to entry.
Supply shifts outwards, and firms have to take a lower price.
Therefore, only normal profit is made in the long run.

Question 10

Why is perfect competition impossible?

Answer 10

-Most firms have some amount of price setting power.
-Differentiated products (e.g. brands).
-Rare for entry & exit in an industry to be costless.