6) Perfect Competition Flashcards
define market structure
the market environment within which firms operate
define perfect competition
a form of market structure that produces allocative and productive efficiency in long-run equilibrium
what is a price taker?
a firm that must accept whatever price is set in the market as a whole
what and where is allocative efficiency?
achieved when consumer satisfaction is maximised. Shown on a market/industry diagram at MC=MB, or S=D, and consumer and producer surpluses are maximised. Shown on a firm diagram at P=MC.
what and where is productive efficiency?
attained when a firm operates at minimum average total cost, choosing an appropriate combination of inputs (cost efficiency) and producing the maximum output possible from those inputs (technical efficiency). Shown on a firm diagram at the bottom of the AC curve.
what is a homogenous product?
because products are seen as identical by consumers, there is no brand loyalty, so all products are perfect substitutes
what is perfect knowledge?
buyers and firms know prices charged by other firms, and no firm has a superior production technique
analysis:
characteristics in a perfectly competitive market?
there are many sellers, the product is homogeneous, there is perfect knowledge and there are no barriers to entry or exit, firms have no market power and so are price takers.
why is the demand curve perfectly elastic in perfect competition?
As the firms is a price taker, it faces a perfectly elastic demand curve for its product (as shown in figure 1). This is because the quantity the firm sells is small compared to the size of the market, so does not influence it - meaning that AR for a sale equals MR for a sale.
why can firms not sell above P0?
The firm cannot sell above Po because buyers have full knowledge of the market and will simply buy elsewhere. The firm cannot sell below Po and still profit maximise; Po is where MC=MR so the firm charges Po.
How do you firms profit maximise?
in order to profit maximise, the firm produces Q0 because this is where MC=MR
what is the objective in a perfectly competitive market?
Profit maximisation is an objective
are there lots of buyers and sellers? why?
• There are many buyers and sellers
• No single firm or consumer has market power
• So firms are price takers
is the product homogenous or heterogenous? what does this mean?
• The product is homogeneous
• Products are effectively identical - so are perfect substitutes
• No brand loyalty
• So firms are price takers
are there barriers to entry? what does this mean?
• There are no barriers to entry or exit
• Firms can enter the market without cost
Firms can exit the market without cost
• If there is short-run profit, firms enter the market and compete away the profit before leaving - so there is no long-run profit
is there perfect or imperfect knowledge? what does this mean?
- There is perfect knowledge
• Buyers always know the prices that firms are charging
• All firms have the same knowledge about production methods
how can the government change the nature of a market to make it more competitive?: profit maximisation
they can force companies to have profit maximisation as their primary objective
how can the government change the nature of a market to make it more competitive?: increasing the number if buyers of sellers
- Encourage new enterprises with advice
• Give start-ups subsidies or tax breaks
• Create markets within areas of the public sector - Discourage mergers or take-overs
• Encourage international competition
how can the government change the nature of a market to make it more competitive?: the product is homogenous
Introduce and enforce minimum safety or quality standards
how can the government change the nature of a market to make it more competitive?: no barriers to entry or exit
ensure that firms have access to the same technologies
how can the government change the nature of a market to make it more competitive?: there is perfect knowledge
• Increase consumer knowledge by ensuring comparison information is available
analysis, what happens to super normal profit over time?
In the short run, if a firm is making super normal profit, this attracts competitors. These firms enter the market without barriers to entry. This shifts the industry supply curve to the right and lowers the market clearing price. In the long run this lowers super normal profits to zero.
analysis, short run: what happens if profits fall below normal profits
If profits fell below normal profits, some firms would leave the market as there are no barriers to exit. This shifts the industry supply curve to the left and raises the market clearing price. In the long run this increases profits to a level where supernormal profits are zero.
