3.4.2 Perfect competition

• Perfect competition:

  Market structure with the highest degree of competition. It has the following characteristics:

  -Many buyers and sellers

  -No barriers to entry or exit

  -Buyers and sellers have perfect knowledge

  -Firms produce a homogenous (identical) product

  -Firms are price takers
• What shape is a firm's demand (AR) curve in perfect competition?

  Perfectly elastic (horizontal). This is because each firm is very small relative to the size of the market and therefore they can increase output without pushing down prices.

  Firms are set to be price takers. This means they have to sell at the market price. The demand (AR) curve = MR.
• What is the short run equilibrium in perfect competition?

  In the SR, at least one FoP is fixed and therefore no firms can join or leave the market.

  Firms aim to maximise profits and therefore will produce an output where MC=MR.

  In the SR, firms can be making SNP or losses. Firms will be allocatively efficient (produce an output where P=MC) but not productively efficient (not producing an output at lowest AC).
• What is the long run equilibrium in perfect competition?

  -Only normal profit is made

  -Firms are allocatively efficient (produce an output where P=MC).

  -Firms are productively efficient (produce an output where AC is at its lowest).
• Adv (+) of an increase of competition in a market

  ↑competition -> ↑number of firms:

  -Firms have less market power -> ↓prices -> more allocatively efficient (prices closer to MC) -> ↑consumer surplus

  -↑competition -> firms become less complacent -> less chance of X-inefficiency -> ↓AC

  -Any SNP profit made more likely to be invested in R&D -> dynamic efficiency
• Disadv (-) of an increase in competition in a market

  -↑competition -> each firm produces less output -> less able to exploit EoS -> ↑AC (less productively eff) -> possibly ↑prices

  -Firms less able to make SNP -> less profit to invest in R&D -> less chance of improved products for consumers (less allocative eff)/less chance of improved production processes, which reduce AC (less productive eff) -> lack of dynamic eff.