Perfect Competition

• Define Perfect Competition

  An ideal market structure where all producers and consumers have symmetric information and no transaction costs
• Characteristics of perfect competition:

  • Many buyers and sellers
  • Freedom of entry and exit
  • All firms produce homogeneous products
  • All firms are price takers
  • There is perfect information and knowledge
• What does Free entry and exit require?

  Low sunk costs
• What does sunk costs mean?

  Costs that have been spent already and can't get back.
• What does being a price taker mean for the demand curve?

  It is perfectly elastic
• Close examples of perfect competition

  1. Foreign exchange market
  2. Agricultural market
  3. internet related industries such as ebay
• Efficiencies of perfect competition

  • Firms will be allocatively efficient
  • Firms will be productively efficient.
  • Firms have to remain efficient otherwise they will go out of business. (X-efficiency)
  • Firms are unlikely to be dynamically efficient.
  • If there are high fixed costs, firms will not benefit from efficiencies of scale.
• At what point are firms going to be allocatively efficient?

  P = MC
• At what point will firms be productively efficient?

  Lowest point on AC curve
• Why are firms not going to be dynamically efficient?

  They have no profits to invest in research and development.
• Diagram for perfect competition

  In the short-run, firms are going to be profit maximising

  In the long run, firms will make normal profits
• Why do firms make normal profits in the long run?

  There's no barriers to entry or exit
• Draw Perfect competition diagram in the short run

  A) Firm in Perfect competition

  B) Industry in P.C

  C) S

  D) D

  E) P1

  F) D=AR=MR

  G) MC

  H) AC

  I) P1

  
• In the short run, the individual firm will maximise output where MR=MC (Profit maximisation)
• What happens when supernormal profits are made?

  New firms will be attracted into the industry.

  • What happens then?

  Supply shifts to the right,

  Prices fall,

  Price becomes LRAC,

  Each firm in the industry is making normal profit

  A) Market in P.C

  B) Firm in P.C

  C) P1

  D) P2

  E) S1

  F) S2

  G) D

  H) MC

  I) AC

  J) AR1=MR1

  K) AR2=MR2

  L) Q2

  
• What happens when Losses are made?

  Firms go out of business.

  • What happens the?

  Decrease in supply,

  Supply shifts left,

  Prices increase,

  back to where AR=AC