3.4.2 Perfect Competition Flashcards
1
Q
Characteristics of perfect competition?
A
- a market in which each individual firm is a price taker
- there are no barriers to entry = firms should be able to enter or leave the market quickly + cheaply
- buyers + sellers have perfect knowledge = no firm can charge a price higher than market price as revenue would be zero
- all products are homogeneous = identical = no branding
- firms are profit maximisers
2
Q
Impact of perfect competition on supply + demand
A
- there are very large number of small suppliers in a perfect market
- this means that one producing can increase supply without it impacting market price
- this means they can sell all that they can produce at the market price = price takers
- individual firm therefore faces a perfectly elastic demand curve
3
Q
Why is there only supernormal profit in the short run?
A
- price taker accepts the market price
- AR> ATC = supernormal profit —> this attracts new firms to enter the market under the assumption that there are no barriers to entry
- this leads to an increase in supply = a fall in market price
- profit maximisation is now at the minimum point of ATC = normal profit in the long run
4
Q
What happens if a firm is making a loss in the short run?
A
- ATC>AR = loss
- firms leave the market due to there being freedom of exit
- supply falls + price increases
- as firms keep leaving the market price will keep increasing until at the minimum point of ATC = normal profit
5
Q
limitations of perfect competition theory?
A
- it is only a theoretical extreme made from assumptions - but a useful benchmark to judge other market structures
- most products are not homogenous because there is usually some branding
6
Q
When is the shut down point?
A
- in the short run a firm will close down if the market price is below AVC
- shut down point is AR=AVC
- in the long run when all factors are variable the firm will shut down if the market price is less than ATC
