Perfect Competition

Question 1

What are 5 characteristics underlying perfect competition?

Answer 1

1. Very many sellers and buyers
2. PRICE-TAKERS
3. Perfect information
4. Homogeneous product
5. No barriers to entry/exit

(6. No collusion)

Question 2

Can firms in the long run enjoy supernormal profits? (perfect competition)

Answer 2

No.

New firms are going to be attracted by the supernormal profits in the short run. The outwards shift in the supply curve, causing the price to fall, until P=the lowest point of LRAC.
Now we are making zero profit.

Question 3

What are the benefits of perfect competition?

Answer 3

1. Allocative Efficiency, as in the long run, P=MC. A quantity is being traded where what consumers are willing to pay matches exactly what producers are willing to charge. More so, given that MU=P, then MU=MC - an optimal position of allocative efficiency in consumption.
2. Efficient firms will remain, as inefficient firm will be forced out.
3. Firms produce at minimum of AC and make normal profits. Consumers benefit from lower prices. This also means that there is productive efficiency.
4. Consumer Sovereignty (explained on another card)

Question 4

What is Consumer Sovereignty?

Answer 4

In order to maximise profits, firms will always respond to consumer’s demand. However, firms cannot make abnormal profits in the long run, and they will have to accept the market price.

Consumers will be deciding what and how much will be produced. Consumers, through the market decide. Firms have no power to manipulate the market - they cannot control the price.

Question 5

What are some disadvantages of perfect competition?

Answer 5

1. Lack of variety for consumers
2. Lack of incentive for investment and innovation - this is because of perfect information and homogeneous product.
3. Doesn’t guarantee equity in any way
4. Such firms might lead to negative externalities, and there will be no government intervention to mitigate this.

Question 6

Can firms earn supernormal profits in the short run?

Answer 6

Yes.

Question 7

Can firms sustain losses in the long run?

Answer 7

No.

Question 8

Will the market be productively efficient in the long run?

Answer 8

Yes.

They will be producing at the lowest point of the AC curve.

Question 9

Will the market lead allocative efficiency in the long run?

Answer 9

Yes.

Producing where demand meets supply, in this case when P=MC. And given that MU=P, then MC=MU.

Question 10

Give examples of perfect competition in real life.

Answer 10

Agricultural markets

Question 11

Why do we study perfect competition if it doesn’t exist in real life?

Answer 11

It is a useful model for explaining how supply and demand impact prices and buyer and seller behaviours. It provides a useful model for explaining how supply and demand affect price and behaviour in a market economy.

Studying this model, helps economists develop model and theories that can be applied to real-world situations, and it allows for the exploration of how market implications impact outcomes such as efficient, equity and welfare.