Perfect competition

Question 1

Perfect competition

Answer 1

a form of market structure that produces allocative and productive efficiency in long-run equilibrium

Question 2

Allocative efficiency

Answer 2

achieved when consumer satisfaction is maximised.

Shown on a market diagram at MC=MB, and consumer and producer surpluses are maximised. Shown on a firm diagram at P=MC.

Question 3

Productive efficiency

Answer 3

attained when a firm operates at minimum average total cost, choosing an appropriate combination of inputs (cost efficiency) and producing the maximum output possible from those inputs (technical efficiency).

Shown on a firm diagram at the bottom of the AC curve.

Question 4

Homogeneous product

Answer 4

products are seen as identical by consumers, there is no brand loyalty, so all products are perfect substitutes

Question 5

Price taker

Answer 5

a firm that must accept whatever price is set in the market as a whole

Question 6

Market structure

Answer 6

the market environment within which firms operate

Question 7

Perfect knowledge

Answer 7

buyers and firms know prices charged by other firms, and no firm has a superior production technique

Question 8

5 Characteristics Perfect competition

Answer 8

1. Profit maximisation an objective
2. Many buyers and sellers
3. Homogeneous product
4. No barriers to entry or exit
5. Perfect knowledge

Question 9

Why are there many buyers and sellers in perfect competition

Answer 9

1. no single firm or consumer has market power, firms can sell everything they produce at the market clearing price
2. so firms are price takers, demand curve horizontal

Question 10

Why is the product homogeneous in perfect competition

Answer 10

1. products are effectively identical (perfect substitutes)
2. no brand loyalty
3. so firms price takers

Question 11

Why are there no barriers to entry or exit in perfect competition

Answer 11

1. firms can enter the market without cist
2. firms can exit the market without cost
3. if there is short-run profit, firms enter the market and compete away the profit before leaving, so no long-run profit

Question 12

Why is there perfect knowledge in perfect competition

Answer 12

1. Buyers always know the prices that firms are charging
2. All firms have the same knowledge about production methods

Question 13

Eg of perfect competition

Answer 13

mango stand

carrots
hand car wash
agriculture

Question 14

Analysis perfect competition long run

Answer 14

In a perfectly competitive market, because there are many sellers, the product is homogeneous, there is perfect knowledge and there are no barriers to entry or exit, firms have no market power and so are price takers.

As the firms is a price taker, it faces a perfectly elastic demand curve for its product (as shown in figure 1). This is because the quantity the firm sells is small compared to the size of the market, so does not influence it – meaning that AR for a sale equals MR for a sale.

The firm cannot sell above P0 because buyers have full knowledge of the market and will simply buy elsewhere. The firm cannot sell below P0 and still profit maximise; P0 is where MC=MR so the firm charges P0.

In order to profit maximise, the firm produces Q0 because this is where MC=MR.

Question 15

Analysis perfect competition short run

Answer 15

In the short run, if a firm is making super normal profit, this attracts competitors. These firms enter the market without barriers to entry.

This shifts the industry supply curve to the right and lowers the market clearing price. In the long run this lowers super normal profits to zero.

If profits fell below normal profits, some firms would leave the market as there are no barriers to exit.

This shifts the industry supply curve to the left and raises the market clearing price. In the long run this increases profits to a level where supernormal profits are zero.

Question 16

When is perfect competition allocatively efficient

Answer 16

Allocative efficiency is achieved when society is producing the quantity of goods and services that best meets customer preferences; P = MC on the industry diagram

in the short run a perfectly competitive firm can be allocatively efficient

in the long run, a perfectly competitive firm can be allocatively efficient; P=MC

Question 17

When is perfect competition productively efficient

Answer 17

Productive efficiency is achieved when a firm operates at minimum average cost; the equilibrium quantity is produced at the bottom of the AC curve.

in the short run a perfectly competitive firm can not be productively efficient because while P=MC, the firm is not producing at the minimum average cost

in the long run, a perfectly competitive firm can be productively efficient; the firm is producing at the minimum average cost.