Competitive markets and perfect competition

Question 1

What are the assumptions of a perfect market? (6) (LNPHFRF)

Answer 1

Large number of buyers and sellers
No one firm is big enough to affect the market price
Perfect knowledge
Homogeneous products
Freedom of entrance and exit
Factors of production are perfectly mobile

Question 2

What is a price taker?

Answer 2

A firm that has to accept the price ruling in the market

Question 3

What does homogeneous mean?

Answer 3

All products are the same irrespective of who makes them

Question 4

What is allocative efficiency?

Answer 4

The optimum allocation of scarce resources that best accords with the consumers’ pattern of demand

Question 5

Why can’t a firm, in a perfectly competitive market, make supernormal profits?

Answer 5

If one firm makes supernormal profit, other firms will enter the industry, which will shift the supply curve to the right, lowering the price

Question 6

Where is the long run equilibrium position for a firm in perfect competition?

Answer 6

ATC = AR

Question 7

What is the optimum output?

Answer 7

The combination of fixed and variable factors that minimises ATC

Question 8

What is static efficiency?

Answer 8

Both allocative and productively efficient at a point in time

Question 9

What is dynamic efficiency?

Answer 9

Efficiency over time - new products, techniques and processes which increase economic growth

Question 10

If price is above the average variable cost curve, how will the firm close down?

Answer 10

The firm will continue production to offset some of its fixed costs and close down slowly

Question 11

If price is below the average variable cost curve, how will the firm close down? Why?

Answer 11

The firm will shut down immediately

It cannot afford to pay for its labour and raw materials