Schedule H - Perfect Competition Flashcards
Perfect competition describes a market structure whose…
… assumptions are strong and therefore unlikely to exist in the majority of real-world markets.
What are the strong assumptions we have for perfectly competitive markets?
- Homogenous goods - no product differentiation at all
- Large number (Infinite number) of buyers and sellers
- No barriers to entry or exit
- Perfect knowledge for buyers and sellers n
- All firms are price takers
What 2 diagrams must you ALWAYS draw when discussing perfect competition and why?
You must draw the market price and show the perfectly competitive marketing taking from the market price at equilibrium. This is shown because firms in PC markets are PRICE TAKERS
Explain why supernormal profits cannot be made in the LR for PC markets.
- If most firms are making supernormal profits in the SR, this encourages the entry of new firms into he industry, driven by the profit motive
- This will cause an outward shift in market supply, forcing down the ruling market price
- The increase in market supply will eventually reduce the ruling market price until price = average cost
- At this point, each firm in the industry is making normal profit where Price (AR) = Average cost
- Ceteris Paribus, there is no further incentive for movement of firms in and out of the industry and a long run equilibrium is established where price = average cost at output where mr=mc
Why would sub-normal profits in a perfectly competitive market eventually lead to the long run equilibrium anyway?
Firms making sub-normal profits are likely to leave the industry. This causes an inward shift of market supply which then leads to a rise in the market equilibrium price. In the long run, the net exit of firms will allow the remaining firms to earn normal profits where price(AR)=AC
Perfectly competitive markets are allocatively efficient. Explain why
This can be broken down into two reasons:
1. In both the short and long run, price is equal to marginal cost (P=MC or demand=supply) and thus allocative efficiency is achieved.
2. Highly competitive markets will elated to firms producing what consumers demand since, if they do not, they will lose market share to firms that are producing the most desired products.
Highly competitive markets lead to consumer _____ (i.e. the consumer is ‘king’).
Highly competitive markets lead to consumer sovereignty.
True or false? Perfectly competitive markets are always productively efficient. Explain your answers.
False. Productive efficiency occurs when the equilibrium profit maximising output is supplied at minimum average cost. This is attained in the long run for a perfectly competitive market. Output is at the lowest point of AC. If a firm is producing at the lowest point on their AC curve, they must also be X efficient.
What type of efficiency does the perfectly competitive market lack and why?
It lacks DYNAMIC EFFICIENCY.
We assume a PC market produces homogenous goods - in other words, there is little scope for innovation to make differentiated products or establish monopoly power. The lack of any SNP suggest that firms will not have the funds available to reinvest therefore firms in PC are unlikely to be Dynamically Efficient
Give some cons of perfectly competitive market structures
- Consumers face a lack of choice and cannot necessarily find a product that perfectly meets their needs
- Firms are unlikely to be able to grow large enough to benefit from economies of scale
- Lack of dynamic efficiency
Why is a PC market good for consumer welfare?
Lower prices because of many competing firms. The cross-price elasticity of demand for one product will be high, suggesting that consumers are prepared to switch their demand to the most competitively priced products in the market.
Also, low barriers to entry means that the entry of new firms procures competition and keeps prices low.
