4.1- Perfect competition

• Perfect competition


  A market with many buyers and sellers selling homogenous goods with perfect information and freedom of entry and exit.
• Dynamic efficiency

  Efficiency in the long run

  Concerned with new technology and increases in productivity which causes efficiency to increase over a period of time.
• X-inefficiency


  When firms produce at a cost above the AC curve.
• Perfectly competitive market

  A market with no barriers to entry, where a new firm can easily enter and compete against incumbent firms completely equally.
• how is perfect competition useful?

  Lower prices due to many competing firms

  Low barriers of entry

  lower total profits and profit margins than in a monopoly

  Greater entrepreneurship

  Economic efficiency
• In a competitive market, every customer pays the market price because a customer would simply go somewhere else to buy the product if the price were higher, leading to consumer surplus for some customers who would have been willing to pay a higher price.
• In a competitive market, every customer pays the market price because a customer would simply go elsewhere to buy the product if the price rises, leading to consumer surplus for some customers who would’ve been willing to pay a higher price.
• what are characteristics of monopolsitic competition?

  Many firms

  • like perfect competition

  Differentiated products

  • like monopoly

  Few barriers to entry and exit

  • like perfect competition

  No dominant firm

  • like perfect competition

  Downward sloping demand curve

  • like a monopoly

  Some control over price

  Heavy expenditure on advertising and other selling costs
• How is perfect competition useful?

  Greater entrepreneurial activity

  • for competition to be improved and sustained

  economic efficiency

  • move towards productive and allocative efficiency and avoid X-inefficiency

  Low barriers to entry

  Lower prices becuase of many competing firms

  • high XED
• why is perfect competition not a useful assumption?

  Most firms have some amount of price setting power

  Dominance in real world markets of differentiated or branded products

  Highly complex products

  • information gaps

  Impossible to avoid search costs

  • shoe leather costs

  Patents, control of intellectual property and control of key inputs

  Rare for entry and esit in an industry to be costless

  not all businesses are profit maximisers
• A firm in perfect competition is allocatively and productively efficient in the long run
• The assumptions of perfect competition are strong and therefore unlikely to exist in most real-world markets
• Price takers


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

  
• Diagram showing the market response to supernormal profits

  
• Diagram showing perfect competition in the long run

  
• efficiency of perfect competition in the short run

  allocatively efficient but not productively efficient
• Efficiency of perfect competition in the long-run

  Allocative and productive efficiency
• Disadvantages of perfect competition theory

  No scope for economies of scale

  Limited investment

  Less incentives

  Unrealistic assumptions

  • most firms have some price setting power
  • most products are differentiated or branded
  • information gaps (not perfect info)
  • barriers to entry (e.g. patents)

  Theoretical ideal
• Udefulness of perfect competition theory

  Useful to markets closest to the ideal

  • e.g agriculture, commodities, currencies

  Can help a government with policy response

  Provides a yardstick for comparison between markets and to judge behaviour

  • e.g. price, output, profits and efficiency