3.4.2 Perfect competition Flashcards
Perfect competition
Perfect competition is a market where there is a high degree of competition.
However, the word ‘perfect’ does not mean it maximises welfare or produces ideal results. There are few industries which fit this type of market structure, one example may be agriculture but government interferences may prevent it from being so.
In reality, the assumptions made rarely hold and no market is completely perfectly competitive.
Characteristics of perfect competition
For a market to be perfectly competitive, there must be four key characteristics. These mean that demand for the firm’s goods is perfectly elastic, and prices are solely determined by interaction of demand and supply; the firms are price takers:
1) Infinite buyers and sellers
2) No barriers of entry/exit from the industry
3) Perfect knowledge/information
4) Homogenous products
Infinite buyers and sellers
No one firm or customer is able to influence the market. For example, the decision of one firm to double their output or the decision of one buyer to double their consumption will have no effect.
- If the firm did manage to have an effect, this would mean the market was no longer perfectly competitive as there would be one large firm and other smaller firms, or one large buyer and other smaller buyers.
No barriers of entry/exit to/from the industry
This is important as it means that when a business is making profits anyone can enter that market and start producing that product for themselves. As a result, business are unable to make huge profits in the long run and if they are making losses they are able to leave. In the long run, they make normal profits.
Perfect knowledge
This enables firms to know when other firms are making profits which will attract them to join the market. Moreover, all firms have the same costs as they can use the same production techniques. It also means that any attempt to raise prices above the level determined by the market will lead to no sales, as customers will be aware they can buy the same good for a lower price and firms know there is no point lowering the price as they will sell all their goods at the higher price determined by the market.
Homogenous products
- The product must be homogenous, where they are identical so it is impossible to tell the difference between one make and another e.g. semi-skimmed milk.
This is important because it means if a firm raises it price above the competitors’ no one will buy it and they will not gain from lowering their price because they can sell all of your product at the same price as everyone else.
Perfect competition: Profit maximising equilibrium in the short-run
Firms are assumed to short run profit maximise and so the firm will produce at MC=MR. In the short run, it is possible for the firm to make a normal profit, a supernormal profit or a loss
Perfect competition: Profit maximising equilibrium in the long-run
Firms in perfect competition can only make normal profit in the long run
Perfect competition efficiency
● Perfect competition is productively efficient, since they produce where MC=AC. They are also allocative efficient since they produce where P=MC. Thus, they are static efficient.
● However, they are not dynamically efficient. No single firm will have enough for research and development (R&D) and small firms struggle to receive finance. The existence of perfect information also means one firms’ invention will be adopted by another firm and so the investment will give the firm no competitive benefit. Governments tend to have to do all the research.
● Competition should keep costs, and therefore prices, low. However, firms will be unable to benefit from economies of scale and this may mean costs are higher than they otherwise could be.
