3.4.2 - Perfect competition

Question 1

What are the 5 main assumptions of perfect competition?

Answer 1

1) product is homogenous
2) perfect knowledge/information
3) firms are small (relative to market size) and numerous
4) no barriers to entry and exit
5) firms are price takers

Question 2

Perfect competition profit

Answer 2

firms in perfect competition can only make profit in the short run, since there are no barriers to entry

Question 3

Is perfect competition efficient?

Answer 3

Yes, productively efficient (bottom of AC curve) and allocatively efficient (D/AR = MC)

Question 4

Can firms in perfect competition make profit?

Answer 4

Not in LR, new firms enter to ‘steal profit’ -> S1 to S2 and D1 to D2, they lower the market price. After price decreases (P1 to P2) firms now make normal profit

Question 5

Profits and losses

Answer 5

A firm can only make a supernormal profit or loss in the short run in perfect competition, but will always make normal profit in the LR

Question 6

What is freedom of exit?

Answer 6

Loss making firms leave since there’s no barriers to exit, so market supply decreases