Perfect competition 3.4.2

What are key assumptions of perfect competition?

• Homogeneous products (they are all perfect substitutes)

• All firms have equal access to factors of production.

• Many buyers & sellers (no monopoly or monopsony power)

• Sellers must act independently (no price collusion)

• Free entry into and exit out of the market.

• Perfectly elastic demand curve for each individual firm.

• Perfect knowledge/ information for buyers/ sellers about prices and equality of what is being sold.

• Profit maximisation is assumed as the default objective of firms and consumers are assumed to be utility maximisers when making purchasing decisions.

What are 4 examples of (near) perfect competition?

• sporting bets on a race course.

• flower sellers at a wholesale market.

• fruit sellers in a street market.

• multiple ‘identical’ bars in Spanish tourist resorts.

What are price-taking firms?

Firms that do not have the ability to influence the price of the product they produce, they have to accept the market price for their product- they can’t charge more or less than the market price.

What happens if the market price is lower than the average cost of production?

Firms will incur losses

What happens if the market price is higher than the average cost of production?

Firms will earn profits.

What is a firm known as in perfect competition in the short run?

A passive taker

How do you show the market price in perfect competition on a graph?

AR = MR (there is a perfectly elastic demand for each firm)

What two things does profit/ loss depend on?

1. ruling market price.

2. the short run costs of each seller.

What does adding new firms do to the price/ what happens in the long run?

Cause prices to drop.

What is the role of supernormal profit in a perfectly competitive market?

It signals for firms to enter the market.