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 17

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

Answer 17

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 18

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

Answer 18

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 19

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

Answer 19

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

Question 20

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 20

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