Perfect Competition Flashcards
MEBF
Characteristics of the Perfect Competition
- Many buyers and sellers.
- Each firm produces identical products.
- Buyers and sellers have perfect information.
- Free entry and exit in the market.
What happens if one firm decides to produce and sell more?
It does not substantially alter market conditions.
Does one firm in a perfectly competitive market produce only a negligible amount of the total quantity?
Yes.
What does a firm producing a standardized or homogenous commodity mean?
Commodity produced is no different from commodities produced by others
What does the assumption of free entry and exit imply?
That additional firms can enter the market if there are economic profits. Firms are free to exit if they are sustaining losses.
What’s the price if firm is a price-taker?
Price is established through supply and demand in the market.
Firms sell products at the market-established price.
What do consumers see in the products of all firms?
They see them as perfect substitutes.
Why don’t firms want to charge a price lower than the market price?
Because it would mean lower revenue and profit.
NNON
Advantages of Perfect Competition
- No information failure and knowledge is shared evenly between all participants.
- No barriers to entry.
- Only normal profits are made.
- No need to spend money on advertising.
DLD
Disadvantages of Perfect Competition
- Do not have incentive to innovate or spend on research and development.
- Less variety.
- Do not enjoy economies of scale.
What does this mean?
P > ATC
Firm makes supernormal profits.
What does this mean?
P = ATC
Firm makes breaks even; makes normal profits.
What does this mean?
P < ATC
Firm suffers a loss
It’s the short-run decision not to produce anything because of market conditions.
Shutdown
It’s the long-run decision to leave the market.
Exit
What happens to fixed costs when a firm shuts down temporarily?
It’s paid by the firm.
What happens to fixed costs when a firm exits?
Firm does not pay.
When do a firm shuts down?
If revenue is less than the variable cost of production
When do outsider firms in perfect competition become attracted to the industry?
When there are supernormal profits.
What’s the effect of entry of outsider firms to a perfect competition with supernormal profits?
It shifts the industry supply curve to the right, which drives down prices until supernormal profits are exhausted.
What happens to the industry supply curve when firms leave the market?
It will shift to the left, which raises price and enables those left to have normal profits.
It is based on all production costs.
Economic Profit/Supernormal Profit
It represents a normal rate of return for the business.
Zero Economic Profit
What happens when the economic profit is greater than zero?
Business is earning more than normal return
It means that price equals average total cost.
P = ATC
Zero Economic Profit
What are the usual description of long run equilibrium?
- Quantity of the product supplied = Quantity demanded by consumers
- Each firm maximizes proft, given prevailing market price.
- Each firm earns zero economic profit so there are no incentive for other firms
What does profit maximization depends on?
It depends on producing a given quantity of output at the lowest possible cost.
What does the long-run equilibrium requires?
Zero Economic Profit
What do firms ultimately produce?
The output level associated with minimum long-run average total cost.
