3.1.10 - Perfect Competition

Question 1

What is a defining characteristic of goods in perfect competition?

Answer 1

All goods are homogeneous (i.e., identical)

There is no branding, leading to no consumer preference between firms.

Question 2

How does the number of buyers and sellers affect market price in perfect competition?

Answer 2

A large number of buyers and sellers means individual actions have no influence on market price

Each firm and buyer represents a small part of total supply and demand.

Question 3

What is the significance of barriers to entry or exit in perfect competition?

Answer 3

There are no barriers to entry or exit, allowing firms to enter or leave freely

This occurs quickly and without cost.

Question 4

What type of knowledge do firms and consumers have in perfect competition?

Answer 4

Firms and consumers have perfect knowledge of market conditions

They are aware of prices and activities of other market participants.

Question 5

What do firms in perfect competition seek to maximize?

Answer 5

Firms seek to maximize profits by producing where MC=MR

MC = Marginal Cost, MR = Marginal Revenue.

Question 6

What allows consumers to switch sellers in perfect competition?

Answer 6

Consumers can move freely from one seller to another without obstacles

This includes no transport costs preventing purchases from any firm.

Question 7

In perfect competition, why do customers buy from firms charging the lowest price?

Answer 7

Customers always buy from firms charging the lowest price because all units are identical

This leads to price competition among firms.

Question 8

What is a Price-Taker?

Answer 8

A price taker is a buyer or seller in a competitive market who has no control over the market price and must accept it as it is.

Question 9

Why are all firms in Perfect Competition Price Takers?

Answer 9

Each firm accounts for only a tiny proportion of the total supply in the industry

Therefore, no firm can influence the market price through their supply decisions, meaning they have no control over the price they charge.

Question 10

What happens if a firm tries to charge more than the market price in perfect competition?

Answer 10

• Consumers will switch to another firm
• This is because Consumers have perfect knowledge of market conditions, and there are no boundaries to consumption (e.g. transport costs)

Question 11

What will happen to a firm that charges even a penny above the market price?

Answer 11

It would lose all its customers and sell none of its output

This highlights the competitive nature of the market.

Question 12

What is the implication of being a price taker for a firm’s demand curve?

Answer 12

The firm’s demand curve will be perfectly elastic

This means the firm can sell as much as it wishes at the market price.

Question 13

What are the three consequences of Perfect Competition for firms due to their elastic demand curve in this market structure?

Answer 13

1) Firms will not charge higher prices than the market rate, for if they do their demand will drop to zero

2) Firms will not charge lower prices than the market rate, since it would not be selling any more at a lower price.

3) Firms can sell as much quantity as they want at the Market Rate, since their individual actions will not change this rate.

Question 14

How is Market Price in Perfect Competition determined?

Answer 14

By the Demand and Supply diagrams for the Industry as a whole

Question 16

What does the individual firm’s demand curve represent in perfect competition?

Answer 16

It is also its AR and MR curve.

Question 17

In perfect competition, what must be true about a firm’s MR?

Answer 17

MR is always equal to the price level.

Question 18

What is the relationship between price, MR, and AR for any firm in perfect competition?

Answer 18

Price = MR = AR.

Question 19

What does it imply if MR is constant in a perfectly competitive firm?

Answer 19

Total revenue must increase at a constant rate.

Question 20

What shape does the total revenue curve of a firm under perfect competition take?

Answer 20

It is a straight upward-sloping curve.

Question 21

Fill in the blank: In perfect competition, the demand curve, marginal revenue curve, and average revenue curve are all _______.

Answer 21

[identical]

Question 22

What is the profit-maximising condition for a firm?

Answer 22

A profit-maximising firm will produce at the level of output where MC=MR.

Question 23

In a perfectly competitive firm, what determines price?

Answer 23

Price is determined in the market where industry demand equals industry supply.

Question 24

What is the formula for total revenue?

Answer 24

Total revenue is calculated as p x q.

Question 25

What indicates that a firm is making a profit per unit?

Answer 25

The revenue per unit (AR) is greater than the cost per unit (AC).

Question 26

What does the vertical distance between the AR curve and the AC curve represent?

Answer 26

It shows the profit earned per unit of output.

Question 27

How is total profit earned by the firm calculated?

Answer 27

Total profit is equal to AB x q, where AB is the profit per unit.

Question 28

What does the shaded area ABCP represent in the diagram?

Answer 28

It shows the total profit earned by the firm.

Question 29

What does the area CBqO represent?

Answer 29

It shows the total costs of the firm.

Question 30

What is the significance of producing at the level where MC=MR? (2)

Answer 30

1. It is the profit maximising level of output 2. It is also the loss-minimising level of output

Question 31

True or False: Perfectly competitive firms always make supernormal profits in the short run.

Answer 31

False.

Question 32

What happens if there is a fall in market demand for a perfectly competitive firm?

Answer 32

The firm may incur losses as the market price \of the product decreases.

Question 33

What does the total loss of the firm equal on this diagram?

Answer 33

Total loss is equal to AB x q, where AB is the loss per unit.

Question 34

What does the area PBqO represent?

Answer 34

It shows the total revenue made by the firm.

Question 35

What does the area CAqO represent?

Answer 35

It shows the total costs of the firm.

Question 36

Summary of Firms in Perfect Competition in the Short Run

Answer 36

* Firms in perfect competition can make Supernormal Profits in the short run. * Firms in Perfect Competition can also make losses in the short run * Output will always remain at MC=MR, but whether the firm makes a profit or a loss is determined by the price established by the market.

Question 38

What is the condition for firms to earn supernormal profits in the short run?

Answer 38

AR > AC

Question 39

What happens to supernormal profits in the long run in a perfectly competitive market?

Answer 39

No supernormal profits can be earned

Question 40

What attracts new firms into an industry when existing firms are making supernormal profits?

Answer 40

The potential for earning supernormal profits

Question 41

What is the assumption about Perfect Competition that allows new firms to enter the industry easily in the long run?

Answer 41

There are no barriers to entry

Question 42

What happens if Firms in Perfect Competition are making Super Normal Profits in the Long Run? (3)

Answer 42

1. New Firms will be attracted into the industry, via super normal profits and a lack of barriers to entry. Thus, industry supply curve shifts right, causing market price to fall. 2. Due to market price falling, Super Normal Profits decline, as the gap between AR (Price) and AC shrinks. 3. This process repeats until all supernormal profits have been eliminated, and firms in the market only earn normal profits, causing new firms to stop entering the industry.

Question 43

Fill in the blank: In the long-run equilibrium of a perfectly competitive market, firms earn _______.

Answer 43

normal profits

Question 44

Can perfectly competitive firms make losses in the short run?

Answer 44

Yes, perfectly competitive firms can make losses in the short run. ## Footnote Losses occur when average cost (AC) exceeds average revenue (AR).

Question 45

What happens to firms in an industry making losses in the long run?

Answer 45

Firms will leave the industry. ## Footnote This occurs because there are no barriers to exit.

Question 46

What is the relationship between average cost (AC) and average revenue (AR) when firms are making losses?

Answer 46

AC > AR. ## Footnote This indicates that firms are not covering their costs.

Question 47

What occurs to market supply and price in perfect competition when firms exit an industry?

Answer 47

Total industry supply will fall and thus market price will increase. ## Footnote This is a result of reduced competition and supply.

Question 48

What is the result when all losses have been eliminated in a perfectly competitive market?

Answer 48

Firms will earn only normal profits. ## Footnote Normal profits occur when AC equals AR.

Question 49

What is the condition for firms to stop leaving the industry?

Answer 49

Firms stop leaving when they are earning only normal profits. ## Footnote This occurs when AC=AR.

Question 50

What is long-run equilibrium in a perfectly competitive market?

Answer 50

Long-run equilibrium is when no losses are made (i.e. AC=AR). ## Footnote In this state, firms are operating efficiently.