Chapter 13 - Perfect competition

• What is perfect competition in economics?

  It is an idealized market structure.
• What are the key characteristics of a perfectly competitive market?

  Homogeneous products, free entry and exit, and perfect information.
• What does it mean for products to be homogeneous in perfect competition?

  They are all perfect substitutes.
• What is assumed about firms in a perfectly competitive market regarding production factors?

  All firms have equal access to production factors.
• How many buyers and sellers are there in a perfectly competitive market?

  Many buyers and sellers exist.
• What is the behavior of sellers in a perfectly competitive market?

  Sellers must act independently without collusion.
• What is the nature of entry and exit in a perfectly competitive market?

  Entry and exit are free and costless.
• What type of demand curve do individual firms face in perfect competition?

  Perfectly elastic demand curve.
• What is assumed about knowledge in a perfectly competitive market?

  Perfect knowledge for buyers and sellers.
• What is the default objective of firms in perfect competition?

  Profit maximization is assumed.
• What is the relationship between marginal cost and marginal revenue for profit maximization?

  Firms set $MC =$$MR$.
• What does it mean for firms to be price takers in perfect competition?

  Firms accept the market price as given.
• What happens to firms' profits when the market price is above average cost?

  Firms earn profits.
• What happens if the market price is below average cost?

  Firms incur losses.
• What is the implication of supernormal profits in the short run?

  It signals firms to enter the market.
• What is the effect of losses on the number of firms in the market?

  Fewer firms will remain in the market.
• What is the role of supernormal profit in a perfectly competitive market?

  It allows firms to grow and invest.
• What are the key assumptions of perfect competition?

  • Homogeneous products
  • Equal access to production factors
  • Many buyers and sellers
  • Independent seller actions
  • Free entry and exit
  • Perfectly elastic demand
  • Perfect information
  • Profit maximization
• What happens in the short run when firms in perfect competition make losses?

  • Firms exit the market
  • Remaining firms may increase prices
  • Market supply decreases
• What happens in the short run when firms in perfect competition make supernormal profits?

  • New firms enter the market
  • Increased competition
  • Market supply increases
• Which of the following is not a characteristic of perfect competition?

  A small number of firms.
• What is the role of supernormal profit in a perfectly competitive market?

  It signals to firms to enter the market.
• What happens to the number of firms if most firms are making strong profits?

  More firms will enter the market.
• Which of the following is not a characteristic of perfect competition?

  A small number of firms
• What is the role of supernormal profit in a perfectly competitive market?

  It signals to firms to enter the market
• If a firm in perfect competition has MR of £2.00 and MC of £2.50, what is likely to happen?

  Price will be unchanged, and output will fall
• How does a perfectly competitive market adjust to a long run equilibrium?

  • Entry of new firms occurs
  • Market supply increases
  • Price decreases until normal profits are achieved
• What happens to the number of firms in the market if large supernormal profits are being made?

  The number of firms will increase
• What happens to the market price if new firms enter?

  The market price will drop
• What happens when new firms enter a market with supernormal profits?

  • Increased competition
  • Supply increases
  • Price decreases
  • Supernormal profits are competed away
• What does the shaded area in the diagram represent?

  Supernormal profit
• Given the situation in the market, what will happen in the long run?

  Firms will leave until normal profits are made
• Why does price equal marginal revenue equal average revenue in a perfectly competitive firm?

  Perfect knowledge means firms charge the same price
• What is the significance of perfect knowledge in perfect competition?

  It ensures firms charge the same price
• What is the relationship between price, marginal revenue, and average revenue in perfect competition?

  Price = marginal revenue = average revenue