Perfect Competition Flashcards
Characteristics of Perfect Competition
- 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.
Short run
The short run is a period too short for new firms to enter the market.
Marginal revenue
the addition to revenue from selling an additional unit of output
Average revenue
revenue earned per unit of output
Marginal cost
the addition to cost from producing an additional unit of output
Average cost
cost per unit of output
What happens to the market in the long run?
- 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.
Profit
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.
Profit in Short Run
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.
Profit in Long Run
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
Efficiency
Short run - it is allocatively efficient, but not productively efficient.
Long run - it is both allocatively and productively efficient
Allocative/Economic efficiency
When firms allocate resources into the production of goods desired by consumers. It occurs when price equals marginal cost.
AR = P = MC
Abnormal Profit Diagram
Loss Driagram
Perfect Competition Diagram