3.5.3 - Perfect Competition Flashcards

1
Q

Why can perfect competition models be used?

A

As a benchmark to judge whether monopoly functions efficiently or inefficiently, and the extent to which resource misallocation occurs.

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2
Q

What did Adam Smith believe about self-interest?

A

Individuals behaving in self-interest leads to outcomes which are in the common good or public interest if markets are free and competitive.

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3
Q

Why do consumers benefit from many individualistic firms

A

Prices end up being lower than would be the case if the markets were dominated by a few large firms.

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4
Q

What market do economists generally regard as favourable?

A

Competitive.

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5
Q

What does traditional economic theory assume about people?

A

Everyone is motivated by self-interest and by self-interest alone. (Be it firms in monopolies or competitive markets)

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6
Q

A company makes a breakthrough in production that reduces production costs, what happens in a perfectly competitive market?

A

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.

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7
Q

How have mobile phones made markets more competitive?

A

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.

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8
Q

What does each firm in a perfectly competitive market accept?

A

The ruling market price.

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9
Q

How much will a firm supply in 5.4?

A

Where MC = MR.

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10
Q

Why does a firm supply goods at MC=MR in 5.4?

A

The point at which profits are maximised.

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11
Q

Why does the ruling market price become the AR curve in perfectly competitive markets?

A

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.

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12
Q

What is the total sales revenue?

A

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13
Q

What is the total cost?

A

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14
Q

How are abnormal profits found?

A

Subtracting total sales revenue from total costs.

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15
Q

What happens when a firm makes abnormal profit in the short-run?

A

The ruling market price signals to firms outside the market that abnormal profits can be made, incentivising firms to enter the market.

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16
Q

Explain this graph in its entirety.

A

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.

17
Q

What on a graph demonstrates the type of profit (normal, supernormal, subnormal) being made by a firm in perfect competition?

A

Where the ATC curve lies in reference to the AR curve.

18
Q

Where is the productively efficient level of output on an ATC curve?
Why is this productively efficient?

A

The minimum point on an ATC curve.
The ATC are minimised, making it productively efficient.

19
Q

What is productive efficiency?

A

For the economy, occurs when it is impossible to produce one more of a good without reducing production of another good.
For a firm, occurs when the ATC is minimised.

20
Q

What is allocative efficiency?

A

Occurs when it is impossible to improve overall economic welfare by reallocating resources between markets.
In the whole economy, P = MC in every market.

21
Q

What types of efficiency does a perfectly competitive market exhibit?

A

Allocative efficiency.
Productive efficiency.

22
Q

Will perfect competition achieve an efficient allocation of resources?

A

Possibly, it appears to be allocatively and productively efficient.
Productive efficiency combined with allocative efficiency only occurs if :

All firms in the market must benefit from all the available economies of scale. However, as each firm is very small, and takes up a small portion of each market, it is unlikely each firm will meet the MES.

In a perfectly competitive market, all markets are perfectly competitive, meaning P = MC in every market across the world, which is impossible.

There are no positive or negative externalities.

23
Q

What is the MES?

A

Minimum Efficient Scale.

The lowest point on a cost curve at which a company can produce its product at a competitive price.

24
Q

Can price cutting take place in perfectly competitive markets?

A

No. Firms cannot gain extra sales by cutting prices as they are price takers that can sell the desired output at the ruling market price.

25
Q

How competitive is perfect competition?

A

Firms cannot price compete to gain sales.
Firms cannot differentiate products through advertising.

Firms can price cut in an effort to reduce costs to make supernormal profit in the short-run. But every firm has access to the innovation they make, so the profits will be competed away quickly.

From the consumer perspective, the choice from where to buy the product is very high, but there is only one product to buy.

26
Q

What does price indicate in allocative efficiency?

A

The utility or welfare obtained at the margin in consumption.

27
Q

What is price in terms of marginal cost?

A

Price is the opportunity cost in consumption.

28
Q

What does marginal cost measure in terms of production?

A

The opportunity cost of the good in production.

29
Q

What happens in markets where P > MC?

A

Households pay a price for the last unit that is greater than the cost of production for the last unit.

The price is too high, so this good is under-produced and under-consumed.

30
Q

What happens in markets where P < MC?

A

Households pay a price for the last unit that is less than the cost of production for the last unit.

The price is too low, so the good is over-consumed and over-produced.

31
Q

What happens if resources are reallocated from P < MC markets to P > MC markets?

A

Consumer welfare increases.

Prices fall in P > MC markets and prices rise in P < MC markets.

32
Q

What is allocative inefficiency?

A

Occurs when P > MC or P < MC. A good is under-produced and under-consumed, or over-produced and over-consumed respectively.

33
Q

What type of profit do perfectly competitive firms make in the short-run equilibrium?

A

Supernormal.