Perfect Competition

Question 1

What is Perfect Competition

Answer 1

A market model in which when all its assumptions were fulfilled and if all markets operated according to its precepts - the best allocation of resources would be ensured for society as a whole

Question 2

Assumptions for Perfect Competition

Answer 2

Firms aim to maximise profits
There are many participants (both buyers and sellers)
The product is homogenous
There are no barriers to entry or exit in the market
There is perfect knowledge of market conditions
There are no externalities

Question 3

What does the pursuit of self interest by firms and consumers affect the operation of the market and to which assumption in the model of perfect competition is it related to

Answer 3

It ensures the market work effectively

Profit Maximisation

Question 4

Why is the assumptions that there are many participants important for the perfect competition model

Answer 4

There are so many buyers and sellers that no individual trader is able to influence the market price - this means that the market price is determined by the operation of the market

Question 5

Why is the product being homogenous an important assumption to the model of Perfect Competition

Answer 5

No individual seller is able to influence market price

Question 6

Why is the no barriers to entry or exit an important assumption to the Perfect Competition model

Answer 6

Affects the long run equilibrium of the market

Question 7

Why is the Perfect Knowledge assumption important to the model of perfect competition

Answer 7

Buyers can buy a good at the cheapest price as they know the price every firm is charging

Firms that try to charge above the cheapest price will have no takers

Question 8

What is the demand curve for a firm in perfect competition

Answer 8

Perfectly Elastic - Horizontal Line

Question 9

How would a firm react to a change in market price

Answer 9

By changing output - but will always choose to supply output at the level at which MR = MC

Question 10

In the short run - what is a firms supply curve in perfect competition

Answer 10

Short run marginal cost above the point it cuts off SAVC

Question 11

What would be the firms best decision when price falls below short run average variable cost

Answer 11

To exit the market

Question 12

What is the supply curve in the short run for the industry

Answer 12

The supply curves for all the firms in the market into one curve

Question 13

What happens when a firms average revenue is greater than its average cost and where is it located in the graph

Answer 13

It is making supernormal profit

Area between P1, AC1, demand curve and equilibrium

Question 14

What is the market assumption when firms are making supernormal profit

Answer 14

Attracts investors to enter the market - only when profits are above opportunity cost - making more profit than other markets

Question 15

What happens to short-run equilibrium when firms enter the market

Answer 15

Position of the industry supply curve shifts to the right and market place firm

Will fall to a point the firm is no longer making superprofit

If prices were to fall even further - firms would choose to leave the market

Question 16

What happens when a firms average cost exceeds the price when MC = MR (aim to maximise profits)

Answer 16

They make losses between P1, AC1 and equilibrium point

Firm chooses to leave in the long run

But when firms start to exit - market supply curve shifts to the left and equilibrium price starts to fall - firms make normal profit

Question 17

When is the market in equilibrium in the long run

Answer 17

Demand = Supply at the price

Typical firm sets price = marginal costs to maximise profits

It just makes normal profits

Question 18

How does the firm and industry adjust to an increase in demand

Answer 18

In the short run - market price pushes up for the firms - leads to existing firms increasing supply as there is an incentive to increase output - industry supply curve shifts outwards

Firms start making supernormal profits - more firms start entering the market - pushes short run supply curve to the right - process continues until there is no incentive for firms to enter the market

In the short run - supply curve shifts to the right - long urn equilibrium is reached by the entry of new firms

Question 19

What is productive efficiency in perfect competition

Answer 19

When a firm operates at the minimum point of its long run average cost curve

In perfect competition - part of the long run equilibrium

Only achieved in the long run

Question 20

What is Allocative Efficiency in Perfect Competition

Answer 20

When price = marginal cost

Occurs when there is supernormal profits as the market ensures price is equal to marginal cost in the long run

Allocative Efficiency occurs

Occurs in the long run and in the short run

Firms set Price to Marginal Cost in the short run

Question 21

Evaluation of Perfect Competition

Answer 21

Assumptions rarely hold true in the real world

Holds true for some agricultural markets

Allows a glimpse of what the ideal market looks like in terms of resource allocation

Allows for comparison for other market structures