4.1.5.3 Perfect competition Flashcards
What are the key characteristics of perfect competition?
Many buyers and sellers, Price takers, Free entry/exit, Perfect knowledge, Homogeneous goods, Profit maximizers, Perfect factor mobility
Why are firms price takers in perfect competition?
Each firm is too small to influence market price - must accept the equilibrium price determined by industry supply and demand.
What determines price in perfect competition?
Price is determined by the interaction of industry demand and supply - individual firms have no control over price.
What is short-run profit maximization condition?
Firms produce where MC = MR to maximize profits (can earn supernormal profits in short run).
What happens to profits in long-run perfect competition?
Supernormal profits attract new entrants → increased supply → lower prices → profits competed away to normal profit level.
What is the long-run equilibrium condition?
P = MC = AC (normal profits only, no supernormal profits)
What are two types of efficiency achieved in long-run perfect competition?
Allocative efficiency (P = MC), Productive efficiency (produces at minimum AC)
Why might dynamic efficiency be limited in perfect competition?
Lack of supernormal profits reduces funds for R&D and innovation.
What happens when new firms enter a perfectly competitive market?
Industry supply increases → market price falls → existing firms’ profits decrease until only normal profits remain.
What is the significance of free entry/exit?
Ensures no long-run supernormal profits and maintains competitive pressure on prices and efficiency.
How does perfect knowledge affect the market?
Consumers know all prices and product information → ensures firms can’t charge above market price.
Why are products homogeneous in perfect competition?
No product differentiation means consumers choose solely based on price → reinforces price-taking behavior.
What is the advantage of productive efficiency?
Firms produce at lowest possible cost (bottom of AC curve) → minimizes waste of resources.
What is the advantage of allocative efficiency?
Resources allocated according to consumer preferences (P = MC) → maximizes social welfare.
Why might perfect competition be unrealistic?
Assumptions rarely hold - real markets have branding, product differentiation, externalities, and imperfect information.
How does perfect competition serve as an economic benchmark?
Provides ideal standard to compare real-world market efficiency and resource allocation.
What happens if a firm tries to charge above market price?
Loses all customers (perfect substitutes available at market price) → reinforces price-taking behavior.
Why can’t firms earn long-run supernormal profits?
Free entry means any supernormal profits attract competitors until they’re eliminated.
What is the shutdown point in perfect competition?
Where price falls below AVC - firm covers variable costs but not fixed costs → should stop production.
How does perfect competition benefit consumers?
Lowest possible prices, maximum choice (homogeneous goods), and efficient resource allocation.
Why might small firm size be disadvantageous?
Prevents economies of scale → higher average costs than larger firms in other market structures.
How does perfect factor mobility affect the market?
Resources can move freely to most productive uses → supports efficient allocation.
What is the significance of P=MC?
Indicates allocative efficiency - value consumers place on good equals cost of resources used to produce it.
How can perfect competition lead to static efficiency?
Achieves both productive and allocative efficiency in the long run through competitive pressures.
