Perfect Competition Flashcards
What is perfect competition?
A theoretical market that considers how firms behave when competition is perfect
What are 8 conditions of a perfectly competitive market?
- many sellers in the market
- zero barriers to entry and exit
- homogenous
- perfect knowledge
- perfectly mobile factors of production
- all firms the same size
- zero convenience advantages
- price takers
Why are there many sellers?
If there were only a few firms then consumers would lack choice as there would be limited substitutes (consumer choice/ substitutes)
Why are there zero barriers to entry?
Barriers to entry restrict competition so more barriers means less competition
Why are the goods homogenous?
If goods weren’t homogenous then consumers may prefer one good over another leading to the preferred good facing less competition
Why does there have to be perfect knowledge?
Perfect knowledge means consumers have full awareness of the prices and products in the market
If knowledge isn’t perfect then consumers aren’t aware of substitutes which may be better or cheaper
Why do the factors of production have to be perfectly mobile?
This means how well firms can access factors of production, therefore all firms have equal access to factors of production so there are no cost advantages
Why are all firms the same size?
Larger firms (output) have access to economies of scale therefore reduced costs, but perfect competition requires all firms to have equal costs of production
Why are there zero convenience advantages?
This refers to how easy it is to use a firm (e.g. easier to use a local shop over a supermarket that is miles away)
If one firm is easier to use than another they have a competitive advantage which can’t happen with perfect competition
Why do firms have to be price takers?
Firms have to take the market price and are unable to change the price as consumers will change to an identical substitute. Price cannot decrease as price is already at a minimum to remain in the market
Why are firms small in perfect competition?
Demand for an individual firm will be very low and there are many firms so each will have a small market share
Why cant firms increase or decrease their prices?
If a firm increased it’s price then consumers will switch to perfect substitutes. Firms cannot decrease prices as prices will already be cut to the lowest point, thus any further decreases will lead to a loss
Why are firms unable to earn supernormal profits in the long run?
The market has zero barriers to entry so firms will enter and compete away supernormal profits
What would occur to a perfectly competitive firm if theres an increase in market demand?
Average revenue would rise as the firm is a price taker from the equilibrium price of the market, therefore the firm will now earn supernormal profits in the short run until new firms join causing market price to decrease thus average revenue decreases
Why can perfectly competitive markets not have subnormal profits in the long run?
Because firms earning subnormal profits will leave the market until the market is back to earning normal profits, therefore perfectly competitive markets can only earn normal profit in the long run
Is perfect competition allocatively efficient?
Yes demand = supply and AR = MC even as the firm is profit maximizing
Is perfect competition productively efficient?
Yes as AC = MC so goods and services are produced at the lowest point of the AC curve and sold for a low price
Do perfectly competitive firms compete on the products they produce?
No one of the conditions of a perfectly competitive market is that it has homogenous products produced, therefore they compete on price by keeping average costs as low as possible
Why is perfect competition perfectly statically efficient?
- they are allocatively efficient (AR = MC)
- they are productively efficient (AC = MC)
- they maximize net consumer and producer surplus (no dead weight loss)
Is perfect competition dynamically efficient?
No it is not as perfectly competitive firms lack the supernormal profits to invest and investment cannot lead to long run supernormal profits due to no barriers to entry so they aren’t incentivised to either
