Perfect Competition

Question 1

MEBF

Characteristics of the Perfect Competition

Answer 1

1. Many buyers and sellers.
2. Each firm produces identical products.
3. Buyers and sellers have perfect information.
4. Free entry and exit in the market.

Question 2

What happens if one firm decides to produce and sell more?

Answer 2

It does not substantially alter market conditions.

Question 3

Does one firm in a perfectly competitive market produce only a negligible amount of the total quantity?

Answer 3

Yes.

Question 4

What does a firm producing a standardized or homogenous commodity mean?

Answer 4

Commodity produced is no different from commodities produced by others

Question 5

What does the assumption of free entry and exit imply?

Answer 5

That additional firms can enter the market if there are economic profits. Firms are free to exit if they are sustaining losses.

Question 6

What’s the price if firm is a price-taker?

Answer 6

Price is established through supply and demand in the market.
Firms sell products at the market-established price.

Question 7

What do consumers see in the products of all firms?

Answer 7

They see them as perfect substitutes.

Question 8

Why don’t firms want to charge a price lower than the market price?

Answer 8

Because it would mean lower revenue and profit.

Question 9

NNON

Advantages of Perfect Competition

Answer 9

1. No information failure and knowledge is shared evenly between all participants.
2. No barriers to entry.
3. Only normal profits are made.
4. No need to spend money on advertising.

Question 10

DLD

Disadvantages of Perfect Competition

Answer 10

1. Do not have incentive to innovate or spend on research and development.
2. Less variety.
3. Do not enjoy economies of scale.

Question 11

What does this mean?
P > ATC

Answer 11

Firm makes supernormal profits.

Question 12

What does this mean?
P = ATC

Answer 12

Firm makes breaks even; makes normal profits.

Question 13

What does this mean?
P < ATC

Answer 13

Firm suffers a loss

Question 14

It’s the short-run decision not to produce anything because of market conditions.

Answer 14

Shutdown

Question 15

It’s the long-run decision to leave the market.

Answer 15

Exit

Question 16

What happens to fixed costs when a firm shuts down temporarily?

Answer 16

It’s paid by the firm.

Question 17

What happens to fixed costs when a firm exits?

Answer 17

Firm does not pay.

Question 18

When do a firm shuts down?

Answer 18

If revenue is less than the variable cost of production

Question 19

When do outsider firms in perfect competition become attracted to the industry?

Answer 19

When there are supernormal profits.

Question 20

What’s the effect of entry of outsider firms to a perfect competition with supernormal profits?

Answer 20

It shifts the industry supply curve to the right, which drives down prices until supernormal profits are exhausted.

Question 21

What happens to the industry supply curve when firms leave the market?

Answer 21

It will shift to the left, which raises price and enables those left to have normal profits.

Question 22

It is based on all production costs.

Answer 22

Economic Profit/Supernormal Profit

Question 23

It represents a normal rate of return for the business.

Answer 23

Zero Economic Profit

Question 24

What happens when the economic profit is greater than zero?

Answer 24

Business is earning more than normal return

Question 25

It means that price equals average total cost.
P = ATC

Answer 25

Zero Economic Profit

Question 26

What are the usual description of long run equilibrium?

Answer 26

1. Quantity of the product supplied = Quantity demanded by consumers
2. Each firm maximizes proft, given prevailing market price.
3. Each firm earns zero economic profit so there are no incentive for other firms

Question 27

What does profit maximization depends on?

Answer 27

It depends on producing a given quantity of output at the lowest possible cost.

Question 28

What does the long-run equilibrium requires?

Answer 28

Zero Economic Profit

Question 29

What do firms ultimately produce?

Answer 29

The output level associated with minimum long-run average total cost.