Perfect Competition Flashcards
Assumptions of perfect competition
1. Many buyers and sellers
- lots of small firms
- price takers so take the price given by the market and have no influence on price
2. No barriers to entry or exit
- a firm that is outside the industry can easily enter the industry
- low startup costs
3. Homogeneous products
- the products are all the same
- no brand loyalty or pricing power
4. Firms are short-run profit makers
- they operate where MR = MC
5. Firms and consumers have perfect knowledge
- lots of firms have the same prices
- if Firm 1 were to have perfect information and Firm 2 has a lower cop which means that they will have higher profit, Firm 1 has perfect info so will copy the other firms cop and their production proces, so they will also be able to lower their prices causing them to be the same
- consumers are rational and know all the prices so will choose the cheapest good
The demand curve in perfect competition
- perfectly elastic because if one firm decided to increase their prices demand would automatically be zero as consumers have perfect info and will go to a cheaper firm
- because firms are price takers so this is why they take the price giving to them by demand and supply
- firms very small and so have no impact on price
What does the marginal revenue curve tell us?
- marginal revenue curve is perfectly elastic
- in order to sell one additional unit of output, firms will not need to lower the price of each additional level of output or all the previous units
Where will output be set?
Where MR = MC
Once the level of output has been determined, where can the price be found?
At the corresponding point on the demand curve
What happens at the short run equilibrium reached, where average revenue exceeds average costs?
Firms are making super normal profit as AR > AC
What happens at the short run equilibrium reached, where average costs exceeds average revenue?
Firms are making an economic loss as AC > AR
What happens in the long run when average revenue exceeds average costs?
- Firms in the industry are making lots of supernormal profit
- Outside firms are going to want to enter the industry as want to make super normal profit in this industry too
- As the economy expands, more firms are entering the market and supplying more, so the supply curve of the industry shifts to the right
- Demand more spread out between the firms and each individual firm is producing less so quantity demanded for each firm has decreased
- This means that the demand curve (D = AR = MR) shifts downwards
- Even though the industry is grown, firms are producing less
What happens in the long run when average costs exceeds average revenue?
- Firms in the industry are making an economic loss
- Outside firms are going to want to leave the industry as less profitable to produce and cant make any profit
- As the economy expands, more firms are leaving the market and supplying less, so the supply curve of the industry shifts to the left
- Demand less spread out between the firms and each individual firm is producing more so quantity demanded for each firm has increased
- This means that the demand curve (D = AR = MR) shifts upwards
- now only normal profit is being made
What is assumed about the long run costs?
- this model assumes all perfectly competitive firms will have identical cost in the long run
- this is because if firms have perfect information and another firm has a lower cop, the firm with perfect info will copy the production process of the other firm
- they are able to match their costs and therefore have the same price which is lower
Efficiency implications
1. Productive efficiency
- efficiently producing goods and services meaning average costs are minimized
- producing on the MES
2. Allocative efficiency
- price = marginal cost
- optimal amount of resources are being used and allocated to the production of the product
- resources are perfectly following consumer demand
3. Dynamic inefficiency
- don’t have any supernormal profit needed to invest into research and development
4. X-efficiency
- firms are operating at its potential AC curve
- minimizing waste of minimizing costs
- if start to slack they will be outcompeted so incentivized to be efficient
Impact on consumer welfare
1. Low Prices
- lots of firms in the market and there is perfect competition
- if one firm has lower prices due to lower cop, another firm will copy this firm’s production process to also lower their costs and lower their prices
2. No Choice
- all the products will be the exact same as assumption of perfect competition is that all products are homogeneous
- there is also no dynamic efficiency to produce other goods
3. Low Quality
- low quality as firms don’t have any supernormal profit to invest into high quality goods
- firms may not have the incentive to invest into research and development
