Perfectly competitive markets Flashcards
What is a perfectly competitive market?
A market where no single firm has any influence over the price of the product they sell
You are a price taker and you cant influence the price
Give an example of a perfectly competitive market?
Selling apples at a farmers market:
- hundreds of stalls selling the same kind of apples
- if you up your price no one will buy from you and just go to others
- if you sell lower then you wont have much profit but sell out quickly
What are the 5 conditions that need to hold for a perfectly competitive market?
1) Profit Maximisation
2) Homogenous Products
3) Many buyers and sellers
4) Price taking
5) Perfect information
What is profit maximisation?
Every firm has the goal of maximising profit
To maximise profit P = MC (q)
Price = Marginal cost to produce 1 more unit
What does homogenous products mean?
It means that all the firms are selling identical products
e.g all the apples are the same shape, colour, taste and size
If they are not identical then it moves onto monopolistic competition
What does it mean by many buyers and sellers?
If there are so many buyers and sellers it means no individual can influence the price
E.g if you stop selling apples, the supply in the market barely changes or price
What does price taking mean?
Firms accept the price and they don’t set it
You either sell at the market price or don’t sell at all
The market demand curve us perfectly elastic
What does perfect information mean?
Buyers and sellers know everything about the market so if someone tries to change anything the buyers can know and go somewhere else
What is the profit maximisation rule?
The firm chooses to produce at:
P=MC
in order to maximise profit
What are some short run contraints?
Some inputs are fixed and you cant expand them overnight:
if the price is too low to cover costs you have 2 options:
keep producing or shutdown
what is the shutdown rule?
if price is grater than your average variable cost then you should keep producing.
However if your average variable costs are greater than price then you should shut down
How is the long run different to the short run?
In the long run all inputs are variable
if you aren’t making profit in the long run you’ll exit the market
if there is profit in the market then new firms will enter until profit is gone.
What is the exit rule?
if P is greater than average variable cost then stay in the market, if price is greater then exit the market
How do firms get to equilibrium is they are making a profit?
New firms enter - more supply - lower price - profit shrinks - New equilibrium
how do firms get to equilibrium if they are making a loss?
Firms exit - Less supply - Higher Price - Losses shrink - New equilibrium
When does long run equilibrium happen?
P = MC = AC
no firm has incentive to enter or exit the market
Why do firms make zero profit in the long run?
If firms make more profit, then more firms will enter.
This causes supply to increase which then drives down price and results in less profit
If firms are making a loss then they exit, this restricts supply in the market and then increases price, reducing losses
