Perfect Competition Flashcards
Explain the characteristics of Perfect Competition
The characteristics of perfect competition are:
} Many Buyers and Sellers
} Sellers are Price Takers
} Free entry and exit from the market
} Perfect knowledge
} Homogenous goods
} Firms are short run profit maximisers
} Factors of production are perfectly mobile
Explain with the aid of a diagram Short run perfect competition; supernormal profit/loss:
i. In the short run firms can afford to make supernormal profits.
ii. Below diagram shows perfect competition in the short run. The firm is a price taker and therefore accepts the industry price of P1. n the short run the firm produces the normal output of Q1. The shaded area shows the supernormal profits that firms enjoy in the short run.
Explain with the aid of a diagram long run perfect competition; supernormal profit/loss
§ From the abnormal profits made in the short run from perfect competition, and there being no barriers to entry, the market is quickly filled with other firms who want to benefit from the large profits that other firms have been seeing.
§ In turn this increases the supply within the industry
§ His causes S1 to shift to S2, which causes the AR = MR = D line to shift down to AR = MR = D 2
§ This means that firms now operate where they only earn normal profits and therefore do not earn money above their operating costs.
Explain the advantages of perfect comeptition
In the long run there is a lower price. P=MC therefore in the long run it becomes allocatively efficient.
Some firms produce at the bottom of the AC curve and therefore there is productive efficiency
The supernormal profits in the short run are likely to go towards investment in the future and therefore make firms dynamically efficient.
Explain the disadvantages of Perfect Competition
In the long run it is likely dynamic efficiency is going to be affected due to the lack of profits made.
Since firms are small, there will be little to no economies of scale
The assumptions of the model rarely apply in real life. In reality branding, product differentiation, adverts, positive and negative externalities all mean that competition is imperfect.
