Perfect and Monopolistic Competition

Question 1

What are the four main conditions for perfect competition?

Answer 1

1. A large number of small firms
2. All firms produce the same good
3. All firms are price takers
4. No barriers to entry or exit

Question 2

What is the profit maximisation condition?

Answer 2

P = MC

Price = marginal cost

Question 3

What condition decides how much output the firm produces? What does this mean?

Answer 3

MC = MR

Means that firm breaks even up to the last unit of output

Question 4

Draw the graph in perfect competition where the firm makes supernormal profits.

Answer 4

ok.

Question 5

What happens when supernormal profits are made?

Answer 5

More firms enter the market due to no barriers to entry, supply of goods increases and pushes the price down. Supernormal profits are gone.

Question 6

Draw the graph for perfect competition in the long run.

Answer 6

ok.

Question 7

What happens (mathematically) in the long run?

Answer 7

P = MC = min(AC)

Question 8

What is monopolistic competition?

Answer 8

Firms are in close competition yet they have the ability to differentiate themselves to some extent from other competitors.

Question 9

What are the nature of the goods produced in perfect and monopolisitc competition?

Answer 9

Perfect competition: homogeneous goods

Monopolisitic competition: non-homogeneous goods

Question 10

What is a good example of monopolistic competition?

Answer 10

Coffee shop market

Question 11

Draw the graph for monopolistic competition?

Answer 11

ok.

Question 12

Why is the demand curve for monopolistic competition downward sloping?

Answer 12

Firms can set prices to a certain extent without losing customers.

Question 13

Why is the demand curve for perfect competition horizontal?

Answer 13

Because firms are price takers, if they raise prices above that level then they will lose customers.

Question 14

Draw the graph for supernormal profits in monopolistic competition

Answer 14

ok.

Question 15

What is the condition for supernormal profits to be obtained?

Answer 15

p > AC

Question 16

What happens in the long-run when supernormal profits are made in monopolisitic competiton

Answer 16

Supernormal profits attract new firms to the market, customers go to these new firms. Each firms sells fewer goods at a lower price until the demand curve is tangental to the AC curve.

Question 17

What is the shape of the average cost curve and why?

Answer 17

It is U-shaped. At low level of production costs are dominated by fixed costs, but as production is increased there are diminishing returns and so costs rise again.