Perfect Competition Flashcards

1
Q

Characteristics of Perfect Competition

A
  • Unlimited number of buyers and sellers in the market (many firms)
  • No barriers to entry or exit in the market (free entry)
  • Homogenous goods
  • Price takers (firm as price taker)
  • Perfect knowledge
  • Perfect mobility

Imagine: Two identical goods in two identical shops. One cannot put the price up or they won’t sell.

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2
Q

Short run

A

The short run is a period too short for new firms to enter the market.

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3
Q

Marginal revenue

A

the addition to revenue from selling an additional unit of output

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4
Q

Average revenue

A

revenue earned per unit of output

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5
Q

Marginal cost

A

the addition to cost from producing an additional unit of output

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6
Q

Average cost

A

cost per unit of output

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7
Q

What happens to the market in the long run?

A
  • The long run is a period long enough for new firms to enter (or exit) into the market.
  • If potential firms see that profit is being earned they will attempt to enter the market.
  • If firms are making a loss, they will exit the market.
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8
Q

Profit

A

Profit maximising condition: MR = MC.

MC< MR = cost of producing the last unit is less than the revenue from selling it –> continue to produce until Q where MR = MC.

MC > MR = cost of producing the last unit is greater than the revenue from selling it –> reduce output until Q where MR = MC.

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9
Q

Profit in Short Run

A

Abnormal profit - As new firms enter the market, increased competition drives prices down. Prices will keep falling until firms reach the break-even point, where total revenue = total cost.

Loss - When firms making a loss leave the market, the reduced in competition raises prices. Prices will continue to rise until firms reach the break-even point, where total revenue = total cost.

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10
Q

Profit in Long Run

A

However, firms in perfect competition are only able to earn supernormal profit in the short run.

Therefore, in long run, all firms operate at break-even point

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11
Q

Efficiency

A

Short run - it is allocatively efficient, but not productively efficient.

Long run - it is both allocatively and productively efficient

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12
Q

Allocative/Economic efficiency

A

When firms allocate resources into the production of goods desired by consumers. It occurs when price equals marginal cost.

AR = P = MC

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13
Q

Abnormal Profit Diagram

A
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14
Q

Loss Driagram

A
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15
Q

Perfect Competition Diagram

A
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16
Q

Long Run Diagram

A
17
Q

Shape of the demand curve in Perfect Competition

A
  • Perfectly Elastic - any price change causes consumers to switch sellers
18
Q

Why is the demand curve elastic?

A
  • In a perfectly competitive market, firms are price takers and must accept the market price.
  • Goods are homogenous, so consumers can easily switch between sellers.
  • If one seller charges even slightly more, consumers will buy from the cheaper seller. Thus, all sellers charge the same price, at the break-even point.