Perfect Competition

Question 1

Points of interest on cost curve graph for perfect competition

1. Productive efficiency
2. Allocative efficiency
3. Break even points
4. Close down level
5. Loss minimization
6. Profit maximisation
7. Cost of profit maximisation

Answer 1

1. ATC = MC
2. MC = MR
3. ATC = AR
4. AVC = AR
5. ATC = MC
6. MC = MR
7. See graph

Question 2

Assumptions perfect competition:

1. number of firms
2. price control
3. barriers to exit/entry
4. product type
5. dependence
6. economic profit short run
7. economic profit long run

Answer 2

1. very many
2. none (price taker)
3. none
4. homogenous (perfect substitute)
5. independent
6. possible
7. none

Question 3

demand curve for a perfectly competitive firm

Answer 3

Question 4

Explain why a perfectly competitive market cannot make profit in the long run. (barriers to entry)

Answer 4

1. no barriers to entry
2. if earning profits other firms will enter the market
3. as firms enter market supply will shift to the right (number of firms increase)
4. marginal revenue decreases because firms are price takers
5. firms reduce output to where MC = MR
6. market moves to long-run equilibrium where firms break even

Question 5

Explain why a perfectly competitive firm cannot make profit in the long run. (barriers to exit)

Answer 5

1. no barriers to exit
2. if economic losses some firms will leave the market
3. supply curve shifts to the left
4. remaining firms have losses eliminated because of higher price
5. firms break even at this equilibrium price

Question 6

Why do perfectly competitive firms not close down as soon as make economic loss?

Answer 6

• firms want to minimize loss when price falls below the average cost of production
• continue producing at MC = MR until loss is greater than TFC
• when loss at MC = MR quantity larger than TFC will close down