3.4.2: Perfect Competition

Question 1

What are the characteristics of perfect competition?

Answer 1

• Many buyers/ sellers
• Homogenous goods
• Firms are price takers (take price from the market)
• No barriers to entry/ exit
• Perfect information
• No externalities

Question 2

What is the efficiency like in perfect competition?

Answer 2

• 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

Question 3

Why are firms not dynamically efficient in perfect competition?

Answer 3

• As no single firm will have enough for research an development 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.

Question 4

What are the advantages of perfect competition?

Answer 4

• Productive efficiency as firms produce at the bottom of the AC curve
• Lower price in the LR so there is allocative efficiency
• The supernormal profit in SR could increase dynamic efficiency through investment

Question 5

What are the disadvantages of perfect competition?

Answer 5

• Dynamic efficiency in the LR would be limited due to the lack of supernormal profits.
• Lots of small firms so no economies of scale
• The model doesn’t apply in real life, as competition is not perfect.

Question 6

What do many buyers and sellers mean in perfect competition?

Answer 6

• Means that no one firm or customer will be able to influence the market
• eg the decision of one firm to double their output or the decision of one buyer to double their consumption will have no effect.

Question 7

Why is freedom of entry and exit from the industry important in perfect competition?

Answer 7

• 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.

Question 8

Why are homogenous goods important in perfect competition?

Answer 8

• As 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