Perfect Competitions

• Perfect competition

  This is a market structure where there are many firms & competitive prices. Assumptions are strong and therefore unlikely to exist in most real-world markets. A firm is allocatively & productively efficient in the long run.
• Characteristics of perfect competition

  Homogenous Products (all perfect substitutes)

  All firms have access to factors of production

  Large number of buyers & sellers

  Free (costless) entry into and exit from the market

  Price takers & so a perfectly elastic demand curve

  Perfect knowledge / information for buyers/sellers

  Profit maximisation is assumed as key objective - and consumers assumed to be utility maximisers
• Price takers

  An individual or firm that must accept the ruling market price(as set by supply and demand) as it lacks the power to influence the market price
• Diagram(s) showing perfect competition in the short run

  A) MC

  B) ATC

  C) AR=MR

  
• Diagram(s) showing the market response to supernormal profits

  A) AR=MR

  B) ATC

  C) MC

  
• Diagram(s) showing perfect competition in the long run

  A) MC

  B) ATC

  C) AR=MR

  
• Efficiency of perfect competition in the short-run

  Market structure that has allocative efficiency but not productive efficiency.
• Efficiency of perfect competition in the long-run

  Market structure that has allocative and productive efficiency
• Allocative efficiency

  This is achieved when society derives the most possible utility from its scarce resources. The optimum allocation of resources that meets with consumer demand. Price = marginal cost.
• Productive efficiency

  This entails producing goods and services at the lowest possible average cost for any level of output.
• Dynamic efficiency

  Efficiency over time. It is concerned with the future and is linked with new products, processes and R&D that are likely to lead to economic growth and standards of living improving
• Disadvantages of perfect competition theory

  No scope for economies of scale

  Limited investment

  Limited incentives

  unrealistic assumptions

  most firms do have some price-setting power​

  differentiated/branded products​

  information gaps: not perfect info​

  patents -barriers to entry/exit.

  Costless entry/exit?​

  the real world is ignored -it's a theoretical ideal
• Usefulness of perfect competition theory

  Useful for those markets closest to the ideal e.g. agriculture, commodities, currencies

  It provides a yardstick for comparison between markets and to judge behaviour e.g. price, output, profits and efficiency​

  It can help a government with policy response​