Perfect Competition

Question 1

What assumptions do we make for a competitive market ?

Answer 1

-all firms profit maximise
-the industry have a larger number of firms, there are many sellers and buyers
-each individual firm is small relative to the size of industry
-firms producing the good/service are price takers (firms demand curve is perfectly elastic). The market determines price
-each producer produces identical products (products are ‘homogenous’)
-there are no barriers to entry or exit
-perfect knowledge for all producers and consumers

Question 2

What output can firms produce at in the short run?

Answer 2

-Loss maximising
-Normal profit
-supper normal profit

Question 3

What is the difference between dynamic and static efficiency?

Answer 3

-static efficiency concerns the efficient use of resources and allocation of goods and services at a single point in time
-dynamic efficiency is about improving the efficiency over time

Question 4

Diagram for a firm in perfect competition in the short run making a supernormal profit

Answer 4

Question 5

Diagram for a firm in perfect competition in the short run and long run making a normal profit

Answer 5

This diagram is possible for both a firm in the short run and long run making a normal profit (AC=AR)

Question 6

Diagram for a firm in perfect competition in the short run making an economic loss

Answer 6

At the output Q2 AC>AR

Question 7

Diagram to illustrate a firm shutting down

Answer 7

Question 8

Why can’t firms make a super normal profit in the long run amidst perfect competition?

Answer 8

This is the only diagram possible for a firm in the long run. The reason being, is because supernormal profit provides a signal (as a result of perfect information) and an incentive for new firms to join the industry. Thins inflow of new firms entering the market cause a shift to the right of the supply curve of the industry. Industry supply increases -> market price falls -> firms in the industry will receive a lower price and will earn a normal profit, where TC=TR: AR=AC

Question 9

Why can’t firms make an economic loss in the long run amidst perfect competition

Answer 9

Economics losses provide signals (because of perfect infromation) for firms to leave the industry. They may choose to earn supernormal/normal profits in other markets (free exit). There is a shift to the left of the industry supply curve.
Therefore, industry supply falls in the long run and the market price increases. Firms remaining in the industry will receive a higher price and will earn a normal profit: TR=TC; AR=AC

Question 10

Assessing efficiency for a firm in perfect competition in the long run diagram

Answer 10

Question 11

Efficiency analysis of a firm in perfect competition in the short run

Answer 11

Question 12

Effects of the industry supply and demand on the individual firms diagram

Answer 12