4.1.5.3 Perfect Competition

• Perfect competition Assumptions:

  • large number of buyers - no monopsony power
  • large number of sellers - no monopoly power
  • Perfect information - symmetric
  • Freedom of entry and exit
  • Homogenous product
• A firm in perfect competition is assumed to be a profit maximising firm
• Monopoly Power: When the a few number of firms hold a large proportion of the market
• Monopsony Power: when a there a few buyers that hold the majority of the power in the market
• The demand curve for a firm in perfect competition is perfectly elastic. The firm is a price taker and must accept the market price
• In the short run, a firm in perfect competition is allocatively efficient because Price = Marginal Cost
• In the short run a firm in perfect competition is not productively efficient because they do not produce at the minimum of the Average Cost Curve
• In the short run a firm in perfect competition will make super normal profit
• In the long run a firm in perfect competition is statically effecient
• Short Run to Long Run Perfect Competition:

  1. More firm enter market due to super normal profits acting as an insentive - freedom of entry
  2. Supply in industry increases, decreasing industry price
  3. Firms accepts lower price
  4. More competition, so firms have less demand
  5. Same marginal cost means profit decrease to the point of normal profit
  6. No more insentive for new firms to join, so firm in in the long run
• Firms are free to join and leave the industry in perfect competition because there is freedom of entry and exit
• A firm in perfect competition is always allocatively effecient

  
• Perfect Competition Short Run

  
• Perfect Competition Long Run

  
• Criticism of Perfect Competition:

  • Information Asymmetries: Perfect knowledge is rarely a reality. Consumers may lack complete information about product quality, leading to potential inefficiencies.
  • Externalities: Unaccounted-for costs or benefits (e.g., pollution) can distort production and resource allocation, undermining efficiency claims.
  • Dynamic Considerations: The model focuses on a static equilibrium, while real markets are dynamic, with innovations and changing preferences disrupting the ideal state.