3.5.3 - Perfect Competition Flashcards
Why can perfect competition models be used?
As a benchmark to judge whether monopoly functions efficiently or inefficiently, and the extent to which resource misallocation occurs.
What did Adam Smith believe about self-interest?
Individuals behaving in self-interest leads to outcomes which are in the common good or public interest if markets are free and competitive.
Why do consumers benefit from individualistic behaviour?
Prices end up being lower than would be the case if the markets were dominated by a few large firms.
What market do economists generally regard as favourable?
Competitive.
What does traditional economic theory assume about people?
Everyone is motivated by self-interest and by self-interest alone. (Be it firms in monopolies or competitive markets)
A company makes a breakthrough in production that reduces production costs, what happens in a perfectly competitive market?
The firm will make significant profits, however, in the long run, other firms within the market gain this information and new entrants are attracted into the market as they enjoy the lower production costs. Ultimately, the consumers benefit from lower prices due to the production costs falling.
How have mobile phones made markets more competitive?
Consumers now have access to more information at their phones than before. Take, for example, two rural fishing villages on either side of a large lake. A consumer in village one will have no knowledge of the prices of fish in the other village meaning there are two separate markets selling the same good in a relatively uncompetitive market.
The inclusion of mobile phones allow fishermen to see where prices are highest and then supply their fish to that village. Eventually, due to technology, the prices would become equal in each village.
What does each firm in a perfectly competitive market accept?
The ruling market price.
How much will a firm supply in 5.4?
Where MC = MR.
Why does a firm supply goods at MC=MR in 5.4?
The point at which profits are maximised.
Why does the ruling market price become the AR curve in perfectly competitive markets?
The line is horizontal as it is perfectly elastic.
The ruling market price is the AR curve as this is the maximum price that a firm can sell a good at. A firm could sell at lower than the AR curve, but that goes against the assumption that firms maximise profits.
What is the total sales revenue?
OQ1AP1
What is the total cost?
OQ1BC1
How are abnormal profits found?
Subtracting total sales revenue from total costs.
What happens when a firm makes abnormal profit in the short-run?
The ruling market price signals to firms outside the market that abnormal profits can be made, incentivising firms to enter the market.
Explain this graph in its entirety.
Initially, too many firms enter the market, causing supply to shift to S2. This causes ATC to be above AR meaning firms are making subnormal profit. This causes firms to leave the market so supply shifts to S3 at which point the ATC = AR meaning all firms are making normal profit at the ruling market price.
