3.3.3.3 - perfect competition

assumptions of perfect competition

1. large number of buyers and sellers

2. homogeneous products

3. no barriers to entry or exit

4. perfect information

5. firms are price TAKERS

profit-maximising equilibrium in the long run under perfect competition

in the short run, firms can make supernormal profits.

this attracts new firms into the market and causes supply to shift right until the point of NORMAL profit, when there is no more incentive to enter the market.

price will decrease and qty will increase until there is no more abnormal profit.

short run profit maximisation rule

if MC < P, firm should increase output because producing one extra unit adds more to revenue than costs

if MC > P, firm should decrease output because producing one extra unit adds more to costs than revenue

if MC = P, firm is maximising profit at current output level

short-run shutdown point

if average revenue (AR) is less than average variable cost (AVC) in the short run, the firm should shut down

productive efficiency under perfect competition (short & long run)

not necessarily productively efficient UNTIL new firms enter the market and the firms operate at the minimum efficient scale, minimising production costs and ensuring output is at the lowest possible cost.

allocative efficiency under perfect competition (short run)

market price = cost of production, meaning consumers are paying exactly what it costs to make the last unit, reflecting social value.

allocative efficiency under perfect competition (long run)

firm will be allocatively efficient in long run because the price equals the marginal cost.