3.4.2 - Perfect competition

• A perfectly competitive market has the following characteristics:

  • Many buyers and sellers
  • Sellers are price takers
  • Free entry to and exit from the market
  • Perfect knowledge
  • Homogeneous goods
  • Firms are short run profit maximisers
  • Factors of production are perfectly mobile
• Perfect competition in the short - run

  
• perfect competition in the Long - run

  
• In a competitive market, profits are likely to be lower than a market with only a few large firms. This is because each firm in a competitive market has a very small market share.
• Advantages:

  • In the long run, there is a lower price. P =MC, so there is allocative efficiency.
  • Since firms produce at the bottom of the AC curve, there is productive efficiency.
  • The supernormal profits produced in the short run might increase dynamic efficiency through investment.
• Disadvantages:

  • In the long run, dynamic efficiency might be limited due to the lack of supernormal profits
  • Since firms are small, there are few or no economies of scale.
  • The assumptions of the model rarely apply in real life. In reality, branding, product differentiation, adverts and positive and negative externalities, mean that competition is imperfect.