Perfect competition

• Characteristics?


  Homogeneous products, perfect knowledge, large numbers of firms in competition, large number of buyers, no collusion, firms are price takers, freedom of market entry and exit
• SR and LR in market structures?

  sr- an equilibrium position which won't last as, usually profit levels, have a tendency to change

  LR- an equilibrium position which will last ceteris paribus
• Price takers?


  Firms are price-takers meaning if they offer a price above the market price then consumers will go to over firms and so will lose revenue

  Resulting in horizontal or perfectly elastic demand, implying perfect substitutes exist- homogenous products
• SR equilibrium- supernormal profit?

  An increase in demand will cause an increase in price for all firms. The demand curve remains horixontal but shifts up and the MC and AC curves remain the same.

  Profit maximisation occurs where MC=MR with the distance between the MC and AC curves represneing the profit per unit.

  When supernormal profits are earnt, firms enter the market and the supply curve shifts right leading to a lower market price, possible causing a loss, if not less supernormal profit or jsut normal profit
• SR equilibrium (loss)?


  Market entry causes a suppy increase shifting the supply curve right leading to a lower market price. Causes a movement down the demand curve (so falls horizontally)

  Results in the AR curve being beloe the AC curve

  MC=MR is 'loss-minimising'

  The loss per unit is equal to the amount the AC exceeds AR

  This encourages firms to leave the market, shifting supply left and prices rise again- firms make supernormal profit and repeats
• LR equilibrium (normal profit)?

  In LR, AC=AR so the firm only makes normal profit, so no signals for market entry or exit

  Unless demand or supply changes the output will remain stable

  At this level, MC=P so are allocatively efficient

  ACs are minimised so productively efficieny

  Consumers recieve the goods they want so their welfare is maximised at the lowest unit cost, so this is why perfect competition is perfect
• Allocative efficiency?


  Occurs when resources are allocated in such as way that the welfare of society is maximised

  Welfare is the positive difference between the benefits and costs of economic activity- assumed to be equal to the price

  Maximised when P=MC

  At output levels before P is greater than MC, society receives welfare from each unit so each is worth producing

  After P is less than MC it brings a social loss so not worth producing
• When should a firm close in the SR?

  Fixed costs are paid in advance so in the SR a firm needs to pay its variable costs. If a firm cannot pay its variable costs is must 'shut down'

  We call the output that this occurs at as the SR shut down position
• SR shut down graph?

  In SR the market is at equilibrium making supernormal profits, demand decreases and demand shifts left so a lower price. The firm may still cover its variable costs and hope that demands will increase. If demand remains low fixed costs will eventually need repaying and may be too expensive.

  When AR is lower than AVC due to a further decrease in demand it reaches the shut down price

  Firms will produce where MR=MC as long as it covers the AVC so above this is the firms supply curve
• Evaluation of shut down price?

  A firm may believe a fall in demand is temporary so keep producing with credit (loan) or savings

  A firm may instead try to cut costs

  A firm may close before shut down price due to being pessimistic about growth in a declining industry or because it takes time to realise they are operating at a loss