Perfect Competition

What does it mean that firms in perfect competition are price takers?

They accept the market price set by supply and demand because no single firm has enough power to influence the price.

Conditions that have to be met for Perfect Competition

• Infinite number of suppliers and consumers

• Each firm is a price taker

• Perfect information

• Homogenous Products

• Zero Barriers to entry and exit

• Profit maximisation

• Zero market power

Why can’t firms in perfect competition earn supernormal profit in the long run?

Because the absence of barriers to entry allows new firms to enter when profits are high, increasing supply and driving prices down to the point where only normal profits remain

What is allocative efficiency and how is it achieved in Perfect Comp?

Allocative efficiency occurs when P = MC or P = MU. In perfect competition, the price mechanism ensures producers supply exactly what consumers need

What is productive efficiency and how is it achieved in Perfect Comp?

Productive efficiency is achieved when production costs are minimized (Bottom of the AC curve). In perfect comp, firms maximise profit and operate where MC = AC in the long run.

Why does perfect competition not lead to dynamic efficiency?

Firms only earn normal profit in the long run, giving them little incentive to invest in R&D or new technology.

What is static efficiency and how does it link to perfect competition?

Static efficiency is achieved when both allocative and productive efficiency are present at a given time. Perfect competition allows this but changes in tech and preferences mean it may not last.

How does perfect knowledge affect market behaviour in perfect competition?

Perfect knowledge removes the need for advertising and ensures that all firms and consumers are fully informed which maintains price uniformity and efficient resource allocation.

What happens when there are externalities in a perfectly competitive market?

if negative externalities exist P < MSC which leads to allocative inefficiency. (Overproduction and overconsumption)

What happens to a firm in perfect competition if it sets a price above the market equilibrium?

It sells nothing, because consumers will buy from competitors offering the same product at the lower market price.

What causes firms to shut down in perfect competition?

If price falls below average variable cost (AVC) in the short run, the firm cannot cover its operating costs and will shut down.

What is the shape of the demand curve faced by a perfectly competitive firm?

Perfectly elastic (horizontal) at the market price, since the firm can sell as much as it wants at that price but cannot charge more.

What is long-run equilibrium for a perfectly competitive firm?

The firm produces where MC = MR = AC = AR; only normal profit is made as new entry or exit eliminates supernormal profits or losses.

What is short-run equilibrium for a perfectly competitive firm?

The firm produces at MC = MR and may make supernormal profit, normal profit, or a loss depending on its average costs.

What is perfect competition?

A market structure with many buyers and sellers, homogeneous products, no barriers to entry or exit, perfect information, and firms that are price takers.