L14 - Perfect Competition

Question 1

What are the two rules of Profit Maximisation?

Answer 1

1) Marginal Output Rule
If firm not shut down, then should produce at level
where MR=MC.
If MR greater than MC, then producing extra unit
increase TR more than TC.

2) Shutdown Rule
The firm should shut down if, for every level of
output the AC is greater than price.
In the short-run:
only one input varies, and only the expenditure on
this factor is an economic cost
p < AVC (average variable cost)

In the long-run:
all factors are variable, so expenditures on all factors are economic costs
p < LRAC (long run average cost)

Question 2

What are the assumptions of Perfect Competition?

Answer 2

Perfect Knowledge

Buyers are Price Takers

Sellers are Price Takers:
Sellers can sell as much as it wants, at a given price
Sellers output choice will not trigger a reaction from
rivals.

No Barriers to Entry/Exit

Homogeneous Products

Question 3

Why does the equilibrium change in the long-run?

Answer 3

(1) All factors are variable which has an impact on the
seller’s costs
(2) Other sellers can freely enter the market

UNDER LONG RUN, THIRD CONDITION OF EQUILIBRIUM:
incumbent sellers will not leave the market
potential sellers will not enter the market

IMPLIES THAT SELLERS MAKE NORMAL PROFITS IN THE LONG RUN.

Question 4

Where is Quantity determined in Perfect Competition?

Answer 4

Q determined where MC = MR

SEE DIAGRAM

Question 5

What happens to Perfect Competition in the Long Run

Answer 5

Due to new entrants. Supernormal profits can no longer be acheived

(SEE DIAGRAM)

Question 6

What does Total Welfare under Perfect Competition look like?

Answer 6

No deadweight loss can be seen.

• Greater Consumer Surplus than Producer

(SEE DIAGRAM)

Question 7

What is the Marginal Output Rule?

Answer 7

If firm not shut down, then should produce at level
where MR=MC.
If MR greater than MC, then producing extra unit
increase TR more than TC.

Question 8

What is the Shut-down Rule?

Answer 8

The firm should shut down if, for every level of
output the AC is greater than price.
In the short-run:
only one input varies, and only the expenditure on
this factor is an economic cost
p < AVC (average variable cost)

In the long-run:
all factors are variable, so expenditures on all factors are economic costs
p < LRAC (long run average cost)

Question 9

What kind of efficiencies can we see in Perfect Competition in the long run?

Answer 9

P=MC gives allocative efficiency

P=MC at the point where AC is minimised gives productive efficiency

Structure of market gives static efficiency