Perfect Competition (3.4.2) Flashcards
What is Perfect Competition?
A market structure in which individual firms have no market power due to the amount of competition and are unable to influence the price
Is there an example of a Perfect Competition market?
There are few industries which fit this type of market structure, one example may be agriculture but government interferences may prevent it from being so. In reality, the assumptions made rarely hold and no market is completely perfectly competitive
What are the characteristics of Perfect Competition?
- Many buyers and sellers- Due to amount of competition, firms are price takers
- No barriers to entry and exit from the industry- Relative ease in which firms can start-up or leave an industry, which increases the levels of competition
- Buyers and Sellers possess perfect knowledge of prices- If one seller lowers price, all buyers will know about it
- The products are homogenous- Firms unable to build brand loyalty as perfect substitutes exist and any price change will result in losing all customers. Demand is perfectly price elastic
Are firms in Perfect Competition Price Takers or Price Makers?
Price Takers due to large number of sellers
What does Perfect Competition look like on a graph for an individual firm as well as in the market?
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In the short run can firms in perfect competition make supernormal profit or losses?
Yes
In the long run can firms in perfect competition make supernormal profit or losses?
They will always return to the long-run equilibrium where they make normal profit.
Why is it a firm in perfect competition will make supernormal profits and losses in the short run but not the long run?
This is due to the nature of free entry and exit in a perfectly competitive market. In the short run firms in perfectly competitive markets can make supernormal profits but as more firms will be attracted to the market and will join due to free entry and exit this will lead to more competition and as firms are price takers the profit will be spread out with all the firms in the market and a firm will achieve just normal profits
What happens if firms in Perfect Competition make supernormal profit in the short-run?
New entrants are attracted to the industry. They are incentivised by the opportunity to make supernormal profit and the no barriers to entry so its easy to join the industry
Why do firms in Perfect Competition always make normal profit in the long run?
Firms making a loss leave the industry and firms making supernormal profit slowly are eradicated as new firms join the industry (more supply) and so profits leveled out so only normal profits achieved
When does Profit Maximisation occur on a graph?
MC=MR
What type of efficiency is Perfect Competition?
Productively efficient since they produce where MC=AC. Also allocatively efficient since they produce where P=MC. They are not dynamic efficient as no single firm will have enough for R + D. One persons invention will be adopted by another firm so there’s no competitive benefit.
Will prices be high or low in perfect competition?
Competition should keep costs and therefore prices, low. However firms will be unable to benefit from economies of scale and this may mean costs are higher than they otherwise could be
What does this short-run supernormal profits of firms in perfect competition look like on a graph?
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What does this short-run losses of firms in perfect competition look like on a graph?
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What does it look like on a graph for individual firms and in the market when there are new entrants in perfect competition? (Profit)
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What does it look like on a graph for individual firms and in the market when there are new entrants in perfect competition? (Losses)
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If firms are making a loss in the short run in perfect competition what should they do?
If firms in perfect competition make losses in the short-run some will shut up. The shut down rule will determine which firms shut down. There are no barriers to exit so its easy to leave the industry
What’s the shut down rule?
If the selling average revenue (p) falls to the AVC in the short-run (o=AVC) the firm should shut down
What does firms leaving the industry in perfect competition do on a graph?
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