Perfect competition (T.O.T.F)

Question 1

What are the 4 conditions for perfect competition

Answer 1

• many small firms which have no influence over price and quantity
• No barriers to entry or exit
• There is a homogenous product
• Consumers have perfect knowledge

Question 2

What are exit costs

Answer 2

Money that cant be recovered if the business shuts down

Question 3

Give 2 examples of exit costs

Answer 3

Advertising
Staff training

Question 4

What is another name for exit costs

Answer 4

Sunk costs

Question 5

Firms in perfect competition are PRICE TAKERS. What price do they take?

Answer 5

Market price

Question 6

In the perfect competition diagram, why is AR=MR

Answer 6

AR is perfectly elastic because the firm is insignificant to the market, it can sell as much as it likes without affecting the market price

Question 7

Where do firms in perfect competition profit max?

Answer 7

Where MC=MR

Question 8

What type of profit do firms in Perfect competition make in the long run

Answer 8

Normal profit

Question 9

What type of efficiency do firms in P.C display

Answer 9

Static efficiency (Productively and Allocatively efficient)

Question 10

At what point are firms in P.C allocatively efficient

Answer 10

Where MC = AR

Question 11

What type of profit can firms in P.C make in the short run

Answer 11

Supernormal profit

Question 12

What occurs when a firm in P.C makes supernormal profit in the short run

Answer 12

Gives the incentive for other firms to join the market

Question 13

What happens to firms’ profit when new firms join a market (shift from short run to long run)

Answer 13

Supply increases which causes a new equilibrium point
Leads to a new price
Firms are price takers so the AR=MR curve moves to the new price
Leading to normal profit

Question 14

What is consumer surplus

Answer 14

The total benefit to consumers of paying a price lower than they would have been prepared to pay

Question 15

What is producer surplus

Answer 15

The extra benefit to those producers who would have been prepared to supply at a price lower than the equilibrium

Question 16

Draw the diagram showing how firms in perfect competition display allocative and productive efficiency

Answer 16

Allocative efficiency occurs where AR = MC. In this case, the firm will be allocatively efficient because at Q1 AR=MC

Productive Efficiency. This occurs on the lowest point of the AC curve. This happens at Q1. This is because firms produce at the lowest point on the AC

Firms in perfect competition don’t intend to be to be allocatively and productively efficient, they aim to p max a yet they still are

Question 17

What does demand being perfectly elastic in PC mean for the firm.
Why is AR=MR

Answer 17

The firm can sell as many units as it likes without affecting the price.

The additional revenue gained from selling one more unit will remain constant

Question 18

How does a firm in perfect competition display aiming to pmax mean they are productively efficient

Answer 18

Pmax point is MC=MR
But MR=AR
Therefore MC=AR which is the allocatively efficient point

Question 19

Draw the diagram showing the short run to long run transition from supernormal profit to normal profit for firms in PC. Explain why this happens

Answer 19

Other firms move their factors of production to the market where supernormal profit is being - this increases supply to s2 (able to join due to no barriers to entry)

This creates a new equilibrium and a lower price - firms in PC are price takers, which lowers the demand curve for the individual firm to D1

Can just shift market supply (ignore market demand changing on diagram)

Question 20

Explain the relationship between AR and MB(marginal benefit) for firms in perfect competition and how it shows allocative efficiency

Answer 20

Allocative efficiency occurs where the marginal cost to society of producing an additional unit of output matches the marginal benefit received by the consumer from buying the output.

For firms in perfect competition, AR=MB, therefore perfect competition achieve that

Question 21

Why are firms in perfect competition productively efficient.

Answer 21

They have to be since any firm which doesn’t achieve productive efficiency will have higher costs than other firms, and since they are price takers, they can’t raise prices and continue to sell, due to the conditions of perfect competition, to make up for this. So in order to remain in the market and make normal profit, they must be productively efficient and produce at the lowest point on the AC curve

Question 22

What is the issue with the perfect competition market structure and its conditions

Answer 22

It is largely theoretical

Question 23

Give 3 examples of how changes in technology may bring industries closer to the market structure of perfect competition

Answer 23

1 - E-commerce platforms such as amazon and shopify: Lowered barriers to entry for small businesses and independent sellers. Entrepreneurs can also now sell directly to consumers without having to pay for large warehouses to hold stock (drop shipping)
However this also strengthens Amazon and shopify in terms of their oligopoly power as e commerce gets more popular. This means whilst the e commerce sector is becoming closer to perfect competition, the industries facilitating this are becoming more oligopolistic.

2- Price comparison websites: For example booking.com and compare the market.com. This leads to price transparency and encourages competition. Therefore prices within the market will be similar in order for firms to remain competitive. However prices transparency may lead a greater ease in implicit collusion due to a more efficient way in indirectly communicating price.
However, it may be said that only the largest firms appear on price comparison websites, and the firms willing to give up a larger commission on these sites, which tends to be larger firms making more profit , meaning in realistic price comparison websites strengthen an oligopolistic market.

3- The rise of online streaming services: Such as Netflix and Spotify. Makes movie and film industry more competitive. Record labels previously control access to production, promotion and distribution services. No services such as ditto allows independent artists to join the market at little cost, increasing competition. (However more artists may mean the product is becoming less homogeneous due to different genres)
Cinemas also previously control access to films, now licensing agreements between online services such as Netflix and film producers mean greater competition.