PC

PC

1. DEFINE: perfect competition is a market structure where there are many buyers and sellers, where there is freedom of entry and exit to the market, where there is perfect knowledge and where all firms produce a homogenous product.

2. ASSUMPTIONS

   • Many small sellers, each of whom produce an insignificant percentage of total market output, and thus exercise no control over the market price.
   • Freedom of entry and exit
   • Products sold are homogenous (perfect substitutes) so a firm in PC has a perfectly elastic demand curve.
   • Perfect information and knowledge
   • No externalities arising from production/consumption which lie outside the market

3. EXAMPLES

   • Foreign exchange reserves
   • Many agricultural markets

4. DIAGRAMS

   • The single firm takes its price from the industry: it is a price taker. Each firm must charge the price where demand = supply and cannot diverge from it.
   • In the long run, firms in PC will make normal profit, because the price is equal to the costs at the profit maximising level of output (where MR=MC)
   • In the short run, firms can make SNP or losses because as industry supply decreases, prices increase meaning higher profit levels as average revenue is higher than average total costs.
   • In the long run, firms are attracted into the industry by incumbent firms making SNP, as there are no barriers to entry and there is perfect knowledge. This shifts the industry supply curve right, driving down price until firms are making normal profit.

5. EFFICIENCY

   • ALWAYS ALLOCATIVELY EFFICIENT in the short and long run
     • ...because they produce where P=MC. At the ruling price, consumer & producer surplus are maximised so noone can be better off without making someone worse off.
   • Productively efficient in the LONG RUN because they produce at their lowest cost (lowest point on SRAC)
   • NOT dynamically efficient because there is no incentive to reinvest/differentiate products to exploit a competitive advantage where there is perfect knowledge.

6. BENEFITS

   • Perfect knowledge - no information failure
   • No barriers to entry and normal profit in long run, so existing firms cannot derive any monopoly power
   • No need to spend money on advertising because of perfect knowledge.
   • Max possible consumer surplus and economic welfare, plus max choice for consumers
   • Max allocative and productive efficiency

7. DRAWBACKS

   • No scope for economies of scale
   • Undifferentiated products provide consumers with little choice
   • Lack of SNP may make investment in R&D unlikely; this is important in some industries (pharm's)

8. DOES IT EXIST?

   • The assumptions of PC aren't true for the majority of markets. It is generally not possible for consumers to possess perfect information, especially as in every industry there is asymmetric information.
   • However, many primary and commodity markets, such as coffee, exhibit many characteristics of PC e.g. inability to influence market price.