6) Perfect Competition

Question 1

define market structure

Answer 1

the market environment within which firms operate

Question 2

define perfect competition

Answer 2

a form of market structure that produces allocative and productive efficiency in long-run equilibrium

Question 3

what is a price taker?

Answer 3

a firm that must accept whatever price is set in the market as a whole

Question 4

what and where is allocative efficiency?

Answer 4

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.

Question 5

what and where is productive efficiency?

Answer 5

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.

Question 6

what is a homogenous product?

Answer 6

because products are seen as identical by consumers, there is no brand loyalty, so all products are perfect substitutes

Question 7

what is perfect knowledge?

Answer 7

buyers and firms know prices charged by other firms, and no firm has a superior production technique

Question 8

analysis:
characteristics in a perfectly competitive market?

Answer 8

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.

Question 9

why is the demand curve perfectly elastic in perfect competition?

Answer 9

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.

Question 10

why can firms not sell above P0?

Answer 10

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.

Question 11

How do you firms profit maximise?

Answer 11

in order to profit maximise, the firm produces Q0 because this is where MC=MR

Question 12

what is the objective in a perfectly competitive market?

Answer 12

Profit maximisation is an objective

Question 13

are there lots of buyers and sellers? why?

Answer 13

• There are many buyers and sellers
• No single firm or consumer has market power
• So firms are price takers

Question 14

is the product homogenous or heterogenous? what does this mean?

Answer 14

• The product is homogeneous
• Products are effectively identical - so are perfect substitutes
• No brand loyalty
• So firms are price takers

Question 15

are there barriers to entry? what does this mean?

Answer 15

• 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

Question 16

is there perfect or imperfect knowledge? what does this mean?

Answer 16

• There is perfect knowledge
  • Buyers always know the prices that firms are charging
  • All firms have the same knowledge about production methods

Question 17

how can the government change the nature of a market to make it more competitive?: profit maximisation

Answer 17

they can force companies to have profit maximisation as their primary objective

Question 18

how can the government change the nature of a market to make it more competitive?: increasing the number if buyers of sellers

Answer 18

• 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

Question 19

how can the government change the nature of a market to make it more competitive?: the product is homogenous

Answer 19

Introduce and enforce minimum safety or quality standards

Question 20

how can the government change the nature of a market to make it more competitive?: no barriers to entry or exit

Answer 20

ensure that firms have access to the same technologies

Question 21

how can the government change the nature of a market to make it more competitive?: there is perfect knowledge

Answer 21

• Increase consumer knowledge by ensuring comparison information is available

Question 22

analysis, what happens to super normal profit over time?

Answer 22

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.

Question 23

analysis, short run: what happens if profits fall below normal profits

Answer 23

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.