Perfect Competition Flashcards
What are the assumptions for P.C?
- Large # of firms
- Firms = price takers
- The products sold are homogeneous
- NO barriers to entry/exit
- All participants have perfect information
What is an example of a perfectly competitive industry?
Closest one is wheat.
Why can’t such markets exist in reality?
Products sold are not homogeneous - different grades of product, different loyalties (eg. regional loyalty such as “buy british”), start up costs exist for virtually everything… therefore there is a barrier to entry.
What does price taker mean?
The firm is too small, relative to the market, to be able to alter the price of the good or service by altering their own output.
“No sales, No sense” idea.
What does homogeneous mean?
The products cannot be distinguished between.
Includes the fact that there is no brand loyalty et cetera.
Why can firms never make abnormal profits/ losses in the long run?
Becuase of perfect information and lack of barriers to entry/exit, firms will enter/leave an industry in pursuit of normal profits (the minimum level of profit required to keep the factors of production in their current use in the long run).
Therefore, the industry supply will change, thus altering the price that firms in the industry can charge.
Why is perfect competition good?
In the Long Run, firms will be making normal profits, so will be both productively and allocatively efficient.
Even in the short run, firms will always by allocatively efficient due to the fact that demand for their product is perfectly elastic and firms will always seek to profit maximise (?) therefore, MC wil always = AR.
Why is perfect competition bad?
No Dynamic efficiency because of perfect information and no barriers to entry/exit, there is no incentive for firms to develop their production techniques, because a profit making idea, or a cost-saving idea, will be immediately available to others in the industry.
Plus, can’t fund such investment as firms only make normal profits.
If it doesn’t exist in reality and is not necessarily amazing, why do we have this theory?
It is a basis from which the assumptions et cetera can be relaxed so that markets can be analysed, thus allowing governments/regulators to determine what type of market would work best in order to maximise welfare.
Evaluation for the theory:
- If firms are making abnormal profits, why don’t existing firms replicate? —- will they then be price takers?
- Surely making abnormal profits for a very short period of time is better than not making abnormal profits at all? — with regards to there being no dynamic efficiency in perfectly competitive markets.
