perfectly competitive markets

Question 1

What are the characteristics of a perfectly competitive market?

Answer 1

Many buyers and sellers
Sellers are price takers
Free entry to and exit from the market
Perfect knowledge
Homogeneous goods
Firms are short run profit maximisers
Factors of production are perfectly mobile

Question 2

Draw the short run equilibrium for a perfectly competitive market and explain it

Answer 2

The firm is a price taker, and it accepts the industry price of P1. In the short run, the firm produces an output of Q1. The yellow shaded rectangle shows the area of supernormal profits earned in the short run. It is assumed that firms are short run profit maximisers.

Question 3

Advantages on a perfectly competitive market

Answer 3

In the long run there is a lower price, P=MC, so there is allocative efficiency.

Since firms produce at the bottom of the AC curve, there is productive efficiency.

The supernormal profits produced in the short run might increase dynamic efficiency through investment.

Question 4

Disadvantages of a perfectly competitive market.

Answer 4

In the long run, dynamic efficiency might be limited due to the lack of supernormal profits.
Since firms are small there are few or no economies of scale.
The assumptions of the model rarely apply in real life. In reality, branding, product differentiation, adverts and positive and negative externalities, mean that competition is imperfect.