Perfect competition

Question 1

Whats a market structure

Answer 1

The market environment in which a firm operates

Question 2

Basic definition of perfect competition

Answer 2

A form of market structure that produces allocative and productive efficiency in the long run equilibrium

Question 3

Definition of a price taker

Answer 3

A firm that must accept whatever price is set in the market as a whole due to a lack of market power

Question 4

Definition of homogenous product

Answer 4

Because products are seen as identical by consumers, there are no brand loyalties so all products are (perfect) substitutes ie agricultural products

Question 5

Define perfect knowledge

Answer 5

When all firms in an industry know prices and costs of other firms and no firm has a comparative production advantage

Question 6

What are the 5 assumptions of perfect competition

Answer 6

1) There are many buyers and sellers
2) the product is homogenous
3) perfect knowledge between all firms
4) profit maximisation is an objective
5) there are no barriers to entry or exit

Question 7

how can the government increase perfect competition

Answer 7

• force companies to have profit maximisation as an objective
• give start up subsidies and tax breaks
• provide information for new firms and for production
• discourage mergers or takeovers
• introduce minimum safety or quality standards
• give firms access to the same technology (deny patents)

Question 8

Advantages of perfect competition theory

Answer 8

• leads to static efficiency= the right amount of products are produce to create an equilibrium at the correct market price due to both allocative and productive efficiency. Therefore S meets D at the right place and the free market is working efficiently
• An ideal market to compare with, and allows governments to identify markets very near to perfect competition and subsequently direct them to perfect competition

Question 9

Disadvantages of perfect competition theory

Answer 9

• Does not lead to dynamic efficiency, no supernormal profits to invest into R +D
• Assumptions very rarely hold so can’t be used to analyse a range of markets as most markets have barriers to entry in the form of startup costs

Question 10

What does the usefulness of perfect competition theory depend on

Answer 10

the usefulness of perfect completion theory depends not on the accuracy of the assumptions made, but the usefulness of the predictions about the behaviour of firms in the market labelled as perfect competition. Are firms going to behave in a way that perfectly conforms with perfect competition??