Perfect Competition

Question 1

Characteristics of Perfect Competition?

Answer 1

• Large number of buyers and sellers (firms)

• Homogenous (identical) products

• Perfect information

• No barriers to entry or exit

• Firms are price takers - they cannot influence the market price; demand
to the firm is perfectly elastic (horizontal) and P=AR=MR

• Supernormal profit is competed away in the long run

Question 2

Perfect Competition & Efficiency:
Productive, Dynamic & Allocative efficiency

Answer 2

Allocative efficiency (P=MC): firms are allocatively efficient in both the short and long run; as a price taker P=MR so when MC=MR, P=MC

Productive efficiency (min AC): in the long run, the firm will produce where the AC curve is at its minimum, so firms are productively efficient

Dynamic efficiency; we assume firms make homogenous goods so there is little scope for innovation and differentiated to try to establish some market power.

However, it is worth noting that in the real world, firms in competitive markets often are very entrepreneurial and innovative, but these markets may not fully meet the theoretical criteria for perfect competition

Question 3

A firm will shut down if its revenue does not cover its _____ costs

(If __< ___) in the short run.

Answer 3

Variable

AR<AVC