Perfect Competition Flashcards
What is perfect competition?
A market with a high degree of competition where firms are price takers
Perfect competition does not necessarily maximize welfare or produce ideal results.
What are the four key characteristics of perfect competition?
- Many buyers and sellers
- Freedom of entry and exit
- Perfect knowledge
- Homogenous products
These characteristics ensure that demand for the firm’s goods is perfectly elastic.
What does it mean for a market to have many buyers and sellers?
No single firm or customer can influence the market
If one firm’s output or one buyer’s consumption affects the market, it is no longer perfectly competitive.
What is the importance of freedom of entry and exit in perfect competition?
It allows businesses to enter markets when profits are available and exit when incurring losses
This leads to firms making only normal profits in the long run.
What does perfect knowledge imply in perfect competition?
Firms know when others are making profits and have the same costs
This knowledge prevents firms from raising prices above the market level.
What is meant by homogenous products in perfect competition?
Products that are identical and indistinguishable from one another
For example, semi-skimmed milk is a homogenous product.
What is the profit-maximizing equilibrium condition for firms in perfect competition?
Firms produce where MC=MR
In the short run, firms can make normal, supernormal profits, or losses.
What happens when firms in perfect competition make supernormal profits?
New entrants are encouraged to enter the market, increasing supply and decreasing prices
This process continues until firms are only making normal profits.
What does it mean for perfect competition to be productively efficient?
Firms produce where MC=AC
This indicates that resources are being used efficiently.
What is allocative efficiency in the context of perfect competition?
Firms produce where P=MC
This ensures that resources are allocated in a way that maximizes total welfare.
Are firms in perfect competition dynamic efficient?
No, they lack sufficient resources for research and development
Small firms struggle to receive finance, and inventions can be easily adopted by competitors.
What is a potential drawback of competition in perfect competition?
Firms may be unable to benefit from economies of scale
This could lead to higher costs than in less competitive markets.
True or False: Perfect competition leads to supernormal profits in the long run.
False
Firms can only make normal profits in the long run due to ease of entry and exit.
