Perfect competition lesson 2/3

What does it mean when we say there is a "large number of firms" in perfect competition?

There are so many buyers and sellers that no single one can influence the market price. They are price takers.

What does it mean that firms are “price takers”?

Firms must accept the market price; they cannot charge more or less, and buyers can purchase as much as they want at that price.

What is meant by “freedom of entry and exit” in perfect competition?

Firms can easily enter or leave the market because there are no barriers to entry or exit.

Why is freedom of entry and exit important?

It ensures resources (labour, capital, etc.) can move freely to industries where returns are higher.

What is “perfect knowledge” in perfect competition?

Buyers know all prices in the market, and sellers know all market conditions.

What happens if one firm tries to raise its price under perfect knowledge?

It would lose all customers, because buyers would switch to other firms selling at the market price.

: What does “homogeneous products” mean?

All firms sell identical products with no branding or differentiation.

Why are homogeneous products important in perfect competition?

Buyers are indifferent about which firm they buy from, so they can switch easily.

What is marginal cost pricing in perfect competition?

Consumers pay a price equal to the marginal cost of production, ensuring efficient pricing.

What is allocative efficiency?

When resources are used where they give the most benefit to society – this happens at MC = MR.

What is technical efficiency in perfect competition?

Firms produce at the lowest point on the average cost (AC) curve

Why can’t firms exploit consumers with monopoly power in perfect competition?

Because no firm has enough market share to influence prices.

Why is less money spent on advertising in perfect competition?

Perfect knowledge means buyers already know about prices and products, and products are identical.

Why is consumer surplus maximised in perfect competition?

Prices are kept low, so consumers get the maximum benefit compared to what they would be willing to pay.

Can firms earn abnormal profit in perfect competition?

Yes, but only in the short run, before new firms enter and compete away extra profit.

Why might firms struggle with research and development (R&D)?

In the long run, firms only earn normal profit, so they can’t fund R&D.

Why don’t firms benefit much from innovation in perfect competition?

Because perfect knowledge means other firms can quickly copy any new technique or invention.

Why don’t firms benefit from economies of scale in perfect competition?

Firms are usually small and can’t expand enough to lower costs through large-scale production.

Why is there a lack of variety for consumers?

Products are homogeneous (identical), so there’s no differentiation or choice.

Why are some industries run as natural monopolies instead of being left to perfect competition?

To prevent consumer exploitation and to ensure efficiency in industries where competition isn’t practical (like utilities).

disadvantages of perfect competition

•Firms may not be able to afford research and development because they   do not earn abnormal profits in the long run. Due to perfect knowledge every other firm in the market would copy the technique and the original ‘inventor’ would not get the long run benefit for the invention. There is little time to benefit from inventions before they are adopted by other firms in the industry due to perfect knowledge.

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•Firms do not benefit from the economies of large scale production.

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•There is a lack of variety for consumers because products are not differentiated.

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•To prevent abuse of consumers, some industries run by state as natural monopolies

what are perfect competition assumptions

-Large number of firms

-Freedom of entry and exit

-Perfect knowledge

-Homogenous products

Perfect competition advantages

-Marginal cost pricing

-Firms have allocative efficiency

-Firms cannot derive any monopoly power (prices r lower)

-Less spent on advertising (perfect knowledge)

-There is a maximum possible consumer Surplus

-Firms can earn abnormal profit in the short tun so some incentive to innovate