Chapter 13: Market structure: perfect competition

Question 1

Define market structure

Answer 1

The market environment within which firms operate

Question 2

Define barriers to entry

Answer 2

A characteristic of a market that prevents new firms from readily joining the market

Question 3

Define perfect competition

Answer 3

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

Question 4

Define price taker

Answer 4

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

Question 5

Define short-run supply curve

Answer 5

For a firm operating under perfect competition, the curve given by its short-run marginal cost curve above the price at which MC = SAVC - for the industry, the horizontal sum of the supply curves of the individual firms

Question 6

Define industry long-run supply curve

Answer 6

Under perfect competition, the curve for the typical firm in the industry is horizontal at the minimum point of the long-run average cost curve

Question 7

Name 5 key characteristics of markets

Answer 7

1. Number of firms and relative size
2. Barriers to entry and exit
3. Homogeneity
4. Degree of shared knowledge
5. Interdependence

Question 8

Name 8 types of barriers to entry

Answer 8

1. Capital costs
2. Sunk costs
3. Economies of scale
4. Natural cost advantage
5. Legal barriers
6. Marketing barriers
7. Limit pricing
8. Strategic and anti-competitive practices

Question 9

Name 7 assumptions of perfect competition

Answer 9

1. Homogenous products
2. All firms have access to factors of production
3. Large number of buyers and sellers
4. Free entry to/exit from market
5. Perfectly elastic demand curve
6. Perfect knowledge
7. Profit maximisation assumed as a key objective

Question 10

Draw a diagram illustrating perfect competition

Answer 10

Diagram sheet

Question 11

What must a firm cover in the short-run?

Answer 11

Its average variable cost

Question 12

What must a firm cover in the long-run

Answer 12

Average total costs

Question 13

Analyse perfect competition in the long-run (4)

Answer 13

1. At P1, not all costs are covered. Firms will exit the market decreasing supply. Price increases to P2 and firms remaining will make normal profits
2. Abnormal profit in the short run will encourage the entry of new firms
3. This causes an outward shift of the market supply curve S1-S2 forcing down the price
4. The increase in market supply will continue until abnormal profits are eliminated and price = AR = AC ceteris paribus, there is no further incentive for firms to enter the market or leave it and long-run equilibrium is established

Question 14

Draw perfect competition in the long-run

Answer 14

Diagram sheet

Question 15

Are perfectly competitive firms profit maximising?

Answer 15

Yes

Question 16

Name 4 advantages of perfectly competitive markets and efficiency

Answer 16

1. In the long-run firms only make normal profits
2. Firms are allocatively efficient because they produce where the extra benefit of a unit is equal to the extra cost
3. Perfectly competitive firms are productively efficient
4. If a firm becomes more efficient than others it earns abnormal profit in the short-run. There is therefore an incentive for firms to innovate but due to the characteristic of perfect knowledge other firms will soon follow

Question 17

Name 2 disadvantages of perfectly competitive markets and efficiency

Answer 17

1. Firms do not make abnormal profit so may be unable to invest in R and D to achieve dynamic efficiency
2. Lack of variety for consumers as products are not differentiated