perfect competition

• Characteristics of a perfectly competitive market structure

  • Many buyers and sellers (infinite)
  • Intense competition
  • Firms sell homogeneous goods/services
  • Firms are price takers
  • No barriers to entry and exit
  • Perfect information of market conditions
• Price takers

  Firms have no ability to set their own prices, they have to charge the market price
• If a firm tries to raise price above market price, they will lose all demand. If they reduce price, they will lose revenue and profit without gaining anything
• Firms in perfect competition are profit maximisers, producing where MC=MR
• Long run equilibrium in perfect competition

  When normal profit is being made, there is no tendency for the market to change
• Supernormal profit in perfect competition

  1. Attracts new firms to enter the market

  2. Increases supply, driving down price

  3. Until normal profit is left
• Subnormal profit in perfect competition

  1. Incentivises firms to leave the market

  2. Decreases supply, driving up price

  3. Until normal profit is left
• Perfect competition

  • Achieves allocative efficiency (price=MC)
  • Achieves productive efficiency (producing at minimum of AC)
  • Achieves X-efficiency (minimising waste and costs)
  • Does not achieve dynamic efficiency (lack of profit to reinvest in innovation)
• In the long run, there is no supernormal profit in perfect competition, so firms cannot be dynamically efficient