Competitive Markets

Alvaro Ferreira6626
Flashcards by Alvaro Ferreira6626, updated more than 1 year ago
Alvaro Ferreira6626
Created by Alvaro Ferreira6626 almost 6 years ago
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Competitive Markets

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Question Answer
Price taker A firm that has to accept the price ruling in the market
Firms operating under conditions of competition will need to remain price competitive and also improve the quality of their goods if they want to be ahead of competitors
Perfect Competition Is a market structure based on the following assumptions Large number of buyers and sellers Buyers/sellers have perfect knowledge Homogeneous products No barriers to entry/exit Perfectly mobile factors of production
Large number of buyers and sellers This is to ensure the good is sold and the firm is a price taker
Homogeneous products All products are the same which means consumers don't have preference over who the buy from and will only buy from the cheapest seller which in this case the price is the same as its set by the industry not the firm
No barriers to entry/exit Any firms can enter the industry as there are no barriers to keep them out. Firms that do not make normal profits can leave anytime and use their factors of production elsewhere. This means that firms will make normal profits in the long run
Factors of production are perfectly mobile Firms can undertake any type of work in any location
What is the outcome of Perfect competition? Whilst it is an unrealistic model, it leads to certain efficient outcomes meaning that competition is important to achieve efficiency and whilst perfect competition may not be possible some degree of competition would be useful
Firms are price takers so if the market price is P* they will have to price their goods at P* because price is elastic. If the firm tries to sell above P* customers will go somewhere else and if it sells below P* the firm will not be maximising output
If firm is producing 10 units at P* (£50) then Total Revenue = £500, Average Revenue = £50 and the Marginal Revenue will be £50 because all units sell at the same price. D=MR=AR=P* Allocative Efficient as surpluses are maximised
How do firms decide their level of output? Firms will produce at the point where MC=MR to profit maximise.
Short run profits and the industry response? A firm makes SNP if the industry's price rises above the firms ATC. At the output Qe (10 units) ATC is £600 C (£60) and Revenue is £800 as P (£80) so the firm is making a £200 abnormal profit Other firms will enter the industry as there are no barriers to entry
In the long run the market responds by leaving all firms making normal profits again, because once firms have exploited all short run SNP as supply for the good in the industry increases so S shifts to S1 resulting in firms lowering their prices to P1 as they are price takers
Long Run Equilibrium Firm is making Normal profits as AR=ATC but is also profit maximising as MR=MC which corresponds to optimum output where a combination of fixed and variable factors minimises ATC. Firm is both allocatively and productively efficient (Static Efficient)
Long Run equilibrium Whilst firms under perfect competition don't grow large enough and don't exploit economies of scale it still results in an efficient allocation of resources. However, firms in the search to cut costs could dispose its waste and create negative externalities which makes it inefficient
Dynamic Efficiency (Perfect competition) Efficiency over time (New products, techniques and processes that increase economic growth) Firms in perfect competition are unlikely to be dynamically efficient because they do not make SNP so they can't afford to.
Firms making losses At a market price of P1 in the industry the firm is making a loss at output Qp where the price is at AC but the firm is making a loss of AR1-AC The firm is producing at the loss minimising point of MC=MR therefore is making the smallest loss possible
When firms under perfect competition make a loss they will decide to leave the market because their objective is to make profits. Therefore, once firms start to leave supply for the good will fall (S-S2 and the price level in the industry will rise again
Entering and leaving the industry The firm is producing where MR=MC so its maximising its profit or minimising losses. At output of 100, TR is £5000 but ATC = £6000, therefore the firm is making £1000 loss because is not efficient. If the price falls below AVC the firm needs to shut down immediately but if its above it can close down slowly
Structural performance and conduct model Individual performance depends ultimately on the industry structure where the variables in the model are structure, conduct and performance
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