3.4.2 - Perfect Competition

Question 1

a) Characteristics of perfect competition

x4

Answer 1

• many buyers and sellers - none who are large enough to influence price = price takers
• freedom of entry to and exit - low barriers to entry/exit = can establish themselves in industry or leave easily and quickly
• perfect knowledge - of P, if set P is higher then market P then D = 0 - price takers
• homogenous goods - no branding/identical products eg agriculture

Question 2

Profit maximising equilibrium in the **short run: **
- assumed firms are profit max (MR=MC)
- price its charged is fixed by the market because firm is price taker

Diagram Analysis - Supernormal Profits

Answer 2

1. Market on the left (cause firms are price takers) - S & D
2. firms are price takers = price caried across - rev cures → AR1=MR1=D1
3. profit is being made - supernormal profits = AC drawn below AR
4. MC has to cut AC at its lowest point
5. firm is profit max = producing where MC=AR
6. AR is higher then AC - unit gain - supernormal profit = total gain
7. this wont last as firms are incentivised to join the market as it is profitable - can enter due to free barriers = S shift right = price down in the market - will keep happening until there is no more incentive to join (normal profit being made)
8. draw step 7 backwards - 1) draw rev curves, 2)draw P across to market, 3)then draw the left shift in S, 4) add on Qs

Question 3

Profit maximising equilibrium in the **short run: **
- assumed firms are profit max (MR=MC)
- price its charged is fixed by the market because firm is price taker

Diagram Analysis - Subnormal Profits

Answer 3

1. Market on the left (cause firms are price takers) - S & D
2. firms are price takers = price caried across - rev cures → AR1=MR1=D1
3. loss is being made - subnormal profits = AC drawn above AR
4. MC has to cut AC at its lowest point
5. firm is profit max = producing where MC=AR
6. AC is higher then AR - unit loss - subnormal profit = total loss
7. this wont last as firms are incentivised to leave the market and to produce their OC instead - can leave due to free barriers = S shift left = price driven up in the market - will keep happening until there is no more incentive to leave (normal profit being made)
8. draw step 7 backwards - 1) draw rev curves, 2)draw P across to market, 3)then draw the left shift in S, 4) add on Qs

Question 4

Profit maximising equilibrium in the long run

whats happening/efficiencies

Answer 4

• perfectly competitive firm will neither make losses nor abnormal profit - when normal profit is being made
• this means that in equilibrium - AR=AC, MC=MR and AR=MR as D curve is horizontal which means AC=AR=MR=MC in LR equilibrium
• Its AE - price is = to MC at q2 - resources are perfectly following consumer demand - P are low, surplus is high, quantity/choice is high - consumers are benefitting
• Its PE - producing at lowest point on AC
• Its Xefficient - firm producing on their AC curve
• no dynamic efficiency as firms do not have the money/SNP to reinvest back into company = no new tech/innovative goods = market wont progress

Question 5

L-R Equilibrium Diagram

Answer 5