Perfect Competition

Question 1

Define NO barriers to entry or exit

Answer 1

• No economies of scale
• No sunk costs
• No patents

Question 2

What are the 4 features of perfect competition ?

Answer 2

• Many small buyers and sellers (opposite of a monopoly)
• No barriers to entry or exit
• Homogenous products (Same goods)
• Perfect Information
• Each individual firm is a price taker
• short-run profit maximisers
• factors of production are perfectly mobile

Question 3

Elastic demand is when PED is between…

Answer 3

negative 1 an negative infinity

Question 4

As PED moves closer to infinity…

Answer 4

Demand becomes more elastic - steeper until flat which is perfectly elastic (straight horizontal line) consumers will respond more to price

Question 5

What are perfectly competitive firms?

Answer 5

Price takers

They have to take the market price, putting their price up just a bit, and their demand will fall to 0 as consumers have perfect information and will immediately switch to substitutes selling at the market price. Always end up with a perfectly elastic demand curve

Question 6

On a perfectly competitive diagram, demand equals…

Answer 6

AR = D = MR

Question 7

Explain how a perfectly competitive market moves to its long run equilibrium. (4 marks)

Answer 7

In the long run, perfect information means potential sellers outside the market will see the opportunity to make supernormal profit by entering the market.

There are no barriers to entry, so new firms will enter the market, increasing supply and decreasing price until AR touches the bottom of the firm’s AC and all the supernormal profit is gone.

New firms will no longer enter the market because they can no longer make supernormal profit, so we have reached the long run equilibrium.

Question 8

What profit is made in the long run of a perfectly competitive market?

Answer 8

Only normal profit

Question 9

When is it a loss of profit?

Answer 9

When AC is above AR

Question 10

What does perfect competition describe?

Answer 10

Describes a market where assumptions are strong and therefore unlikely to exist in most real-world markets

Question 11

Name all the characteristics of perfect competition

Answer 11

REMEMBER HALFPPP

• Homogenous products (all perfect substitutes)
• All firms have access to factors of production
• Large number of buyers and sellers
• Free entry and exit to and from the market
• Perfectly elastic demand curve
• Perfect information
• Profit maximisation assumed as key obejctive

Question 12

How many diagrams do we dram to show a perfectly competitive market?

Answer 12

2

1 for the market (supply and demand)

1 for the individual firm

Question 13

What is the market price determined by in a perfectly competitive market?

Answer 13

The forces of supply and demand

Question 14

Outline the characteristics of a perfectly competitive market on a diagram in the short run

Answer 14

• The ruling market price becomes the AR and MR curve for the firm
• Average revenue = marginal revenue at every level of output
• Supernormal profits represented by area between ac curve and mr=ar=d curve

Question 15

Explain adjustment to the long-run equilibrium in a perfectly competitive market

Answer 15

If most firms are making abnormal (economic) profits in the short run, this encourages the entry of new firms driven into the market by the profit motive

This will cause an outward shift in the market supply forcing down the ruling market price

The increase in market supply will eventually reduce the price until price = LRAC

At this point, each firm in the industry is making normal profit where AR = AC

Assuming ceteris paribus, there is no further incentive for the movement of firms in and out of the industry, and a long-run equilibrium has been established

Question 16

What is the shutdown price in a perfectly competitive market?

Answer 16

A firm needs to be making at least normal profits in the long run to stay in an industry

However in the short run, firms will continue to produce as long as price per unit is greater than or equal to AVC (AR = AVC)

Question 17

Define sunk costs

Answer 17

A cost that has already been incurred and cannot be recovered

Question 18

Define economies of scale and when do they occur

Answer 18

Cost advantages reaped by companies when production becomes more efficient

Occur when a firm can produce goods or services more efficiently as it increases its scale of production

Question 19

Why are firms only short-run profit maximisers?

Answer 19

In the short run, if a firm makes a profit, they can enjoy SNP BUT, this will incentivise new firms to enter the market to gain some of these profits, which can be done due to the low barriers to entry, this increases excess supply which drives down the prices, old firms are competed away, IN the long run, only normal profits are made as existing firm’s profits are competed away

Question 20

pros and cons of perfect competition market

Answer 20

pros

• supernormal profits in the short run - dynamic efficiency through investment

-short-run producing at lowest point on ac curve - productively efficient

• in the long run where p = mc, there is lower price - allocativeley efficient

CONS

• the assumptions of the model rarely apply in real life - imperfect comp
• snp only enjoyed in short run so dynamically efficient limited
• small number of firms means no economies of scale can be enjoyed