Chapter 7: Perfect competition Flashcards
What are the characteristics of perfect competition?
- Large number of buyers and sellers in the industry
- large number of small firms that each produce an insignificant market share and therefore are price-takers - No barriers to entry/ exit
- resources are perfectly mobile so firms that make losses can easily leave and move to another more profitable industry - Perfect information
- buyers have perfect knowledge of the quality and availability of the product + prices in every part of the market
- producers know their COPs and price, potential entrants are aware of the types of profits - Homogeneous products
- products sold by diff firms are identical and thus perfectly substitutable (perfectly price elastic)
What is the price and output decision?
When the firm’s objective is to maximise profits, it would also make price and output decisions based on the marginalist principal where MR=MC when MC is rising
What happens when MR>MC?
The additional revenue gained from selling one more unit of the good is more than the additional cost incurred from selling that one additional unit of the good. This means that the additional unit produced makes a profit that adds to the total profits and thus the firm should increase output level to Qe to maximise profits
What happens when MR<MC
The additional cost incurred from selling one more unit of the good is more than the additional revenue gained from selling that one additional unit of the good. This means that the additional unit produced makes a loss that reduces the total profits and thus the firm should lower output to Qe to maximise profits
When does supernormal profit occur? (TR>TC)
It occurs when the price of the good (P=AR) is greater than the C at the level of output at Qe where MR=MC
When does normal profit occur? (TR=TC)
It occurs when AR=AC
When does subnormal profit occur? (TR<TC)
It occurs when the price of the good (P=AR) is less than the AC at the level of output at Qe where MR=MC
What is the likely long run eqm of PC firms?
normal profits due to the lack of barriers to entry
What is the shut down condition?
- Short run: when TR<TVC
- Long run: when TR<TC
When is allocative efficiency achieved?
Allocative efficiency is achieved when society produces a combination of goods and services that maximises its welfare when P=MC
When is productive efficiency achieved?
Productive efficiency is achieved when the market output is produced at the lowed possible average cost in the long run, at the given state of technology. (Min point of LRAC curve)
When is dynamic efficiency achieved?
Dynamic efficiency is achieved when firms are technologically progressive improving productivity and product quality ro reduce average COP. (Product/ process innovation)
