Perfect Competition and Monopolistic Competition

Question 1

What are the characteristics of a perfectly competitive market

Answer 1

-many, relatively small, buyers and sellers
-price takers
-homogenous products
-perfect information
-independence
-no barriers to entry and exit

Question 2

Go on sketchpad and draw the long run profit maximising equilibrium for a perfectly competitive market

Answer 2

Did you remember:
1. Supply and demand curve for the market
2. AR=MR curve, AC curve and MC curve
3. Price for the market is the same price that the firm takes (price takers)
4. Equilibrium output where
AC=MC=AR=MR

Question 3

Advantages and Disadvantages of perfect competition

Answer 3

Advantages:
-productively efficient
-allocatively efficient
-high competition

Disadvantages:
-only normal profit in the long run
-lack of economies of scale
-dynamically inefficient
-Lack of variety

-Dynamically ineffecient
Firms in perfect competition earn only normal profits in the long run due to free entry and exit.
→ With no supernormal profits, there’s little incentive to reinvest in R&D or innovate.
→ This results in a lack of dynamic efficiency, meaning products and processes may stagnate over time.
→ In the long term, consumer benefits from innovation are lost.

• Unrealistic Assumptions
  Perfect information and identical products rarely exist in the real world.
  → For example, consumers often have brand loyalty or lack full knowledge of prices.
  → This limits the real-world relevance of perfect competition as a model, reducing its usefulness for policy-making.

Question 4

What are the characteristics of a monopolistically competitive market

Answer 4

-many, relatively small, buyers and sellers
-some price making ability
-differentiated products
-imperfect information
-independence
-low barriers to entry and exit

Question 5

Go on sketchpad and draw the SHORT RUN AND LONG RUN profit maximising equilibrium for a monopolistically competitive market

Answer 5

Did you remember:

Short run:
1.Output where MC=MR
2.Supernormal profits

Long run:
1. Output where MC=MR AND AC=AR
2. Normal profit
3. AC doesn’t below AR curve
4. AC intersects MC at AC lowest point

Question 6

Advantages and Disadvantages of Monopolistic competition

Answer 6

Advantages:
-possibly to be dynamically efficient
-possibly to have economies of scale
- opportunity for supernormal profits in the long run
-increased variety for consumers
-more responsive to consumer needs
-Innovation and Non-Price Competition

Disadvantages:
-not productively efficient
-not allocatively efficient
-Short-term profits only (low barriers to entry and exit means that only normal profits are made in the long run)
-Excessive spending on advertising:
A lot of resources are spent on branding and advertising rather than improving product quality.

This can be seen as wasteful from a social perspective.