Perfect Competition Flashcards
What is Perfect Competition
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
Assumptions for Perfect Competition
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
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
It ensures the market work effectively
Profit Maximisation
Why is the assumptions that there are many participants important for the perfect competition model
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
Why is the product being homogenous an important assumption to the model of Perfect Competition
No individual seller is able to influence market price
Why is the no barriers to entry or exit an important assumption to the Perfect Competition model
Affects the long run equilibrium of the market
Why is the Perfect Knowledge assumption important to the model of perfect competition
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
What is the demand curve for a firm in perfect competition
Perfectly Elastic - Horizontal Line
How would a firm react to a change in market price
By changing output - but will always choose to supply output at the level at which MR = MC
In the short run - what is a firms supply curve in perfect competition
Short run marginal cost above the point it cuts off SAVC
What would be the firms best decision when price falls below short run average variable cost
To exit the market
What is the supply curve in the short run for the industry
The supply curves for all the firms in the market into one curve
What happens when a firms average revenue is greater than its average cost and where is it located in the graph
It is making supernormal profit
Area between P1, AC1, demand curve and equilibrium
What is the market assumption when firms are making supernormal profit
Attracts investors to enter the market - only when profits are above opportunity cost - making more profit than other markets
What happens to short-run equilibrium when firms enter the market
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
What happens when a firms average cost exceeds the price when MC = MR (aim to maximise profits)
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
When is the market in equilibrium in the long run
Demand = Supply at the price
Typical firm sets price = marginal costs to maximise profits
It just makes normal profits
How does the firm and industry adjust to an increase in demand
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
What is productive efficiency in perfect competition
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
What is Allocative Efficiency in Perfect Competition
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
Evaluation of Perfect Competition
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
