Perfect Competition Flashcards
What are the characteristics of Perfect Competition?
- Infinite buyers and sellers
- Homogenous goods
- Price takers
- Low barriers to entry/exit
- Perfect information is available
- Firms are profit maximisers [MC=MR]
What does it mean that firms are price takers?
Firms sell homogenous goods, so they have no control over price making abilities. This means that firms must accept the market price set by supply and demand.
What profits are achieved in the short run of perfect competition?
- Supernormal profits are achieved in the short run. AC is lower than AR.
- Subnormal profits are achieved in the short run. AC is higher than AR.
Why might Supernormal Profits not persist in the LR of Perfect Competition?
SNPs attract new firms to enter the market. It is easy to enter given the characteristics of the market structure. This increases supply and lowers prices, until firms are only making normal profits in the long run.
Why might Subnormal Profits not persist in the LR of Perfect Competition?
Subnormal Profits incentivise firms to leave the market and produce their oppurtunity costs, which is easy given the characteristics of the market structure. This shifts supply upwards where prices increase, until there is no longer an incentive to leave the market, leading to normal profits.
Why is the shape of the demand curve in Perfect Competiton Perfectly Elastic?
Because firms are price takers, they need to supply any quantity given at the market price.
Why does the AR and MR curve coincide in Perfect Competition?
Since firms are price takers, the price is constant among all quantities sold, so AR and MR is equal to price.
Why is Perfect Competition considered Efficient?
It achieves all static efficiencies
[AE, PE, XE]
How is Perfect Competition Statically Efficient?
- Firms produce at the point where P=MC and at the lowest point of their AC curve
- The price taking factor indicates resources perfectly follow consumer demand as the price is set by demand and supply forces.
- Costs and wastes are minimised and society surplus is maximised
Why can’t Dynamic Efficiency be achieved in Perfect Competition?
- Firms cannot sustain LR SNP given the threat of new entrants and barriers to entry in this market structure
- This reduces the amount of profit available to reinvest in development and the market does not progress forward
How do firms in Perfect Competition remain Efficient in the LR?
Efficiency is considered as a part of competition. Firms that do not operate at their MES / cost-effective point do not survive in the market, hence, suboptimal firms do not persist in the LR.
How does Perfect Competition create employment?
Given the increased demand and quantity, labour acts as a derived demand, increasing job oppurtunities.
What are some reasons that Perfect Competition is a theoretical extreme / unrealistic market structure?
- Certain degrees of product differentiation may exist in reality
- Presence of Externalities
- Government Regulations / Startup Costs as a Barrier to Entry
- Degree of Efficiency
What are some limitations of Perfect Competition
- Lack of Dynamic Efficieny / Incentive to invest
- Overall Lack of Economies of Scale
- Cost cutting in dangerous areas [i.e areas that cause X-Inefficiency]
Why might there be an overall lack of Economies of Scale in Perfect Competition?
The MC curve of Perfect Competiton may still be higher than a Concentrated Firm
What kind of Externalities/Market Failures can exist in Perfect Competition?
- Negative Production Externalities
- Underestimation in costs/benefits
- Free rider problem
- Adverse Selection
What are some Evaluation Points to consider in argument of Perfect Competition
- Assumption of being statically efficient
- There could be an extent of Dynamic Efficiency
- Role of Regulation
