perfect competition.

perfect competition.

1. features

   • lots of buyers and sellers.
     • nobody has power over anyone else. everybody says the same price and firms are price takers. if the business raises their price no one will buy
   • homogeneous products
     • products are the same. consumers know this. no brand loyalty or marketing
   • perfect knowledge
     • consumers and producers know everything about every option on sale. no externalities, identical costs and profits- no secrets
   • long-run freedom of entry and exits
     • new firms can easily enter when demand is high and leave when demand is low. normal profit only in the long-run. if making subnormal profits firms will leave and return when it returns to normal profit again.

2. perfect competition in the short- run.

   • price charged by the firms are set by the market forces of demand and supply and there are many firms selling homogeneous products.
   • if an individual firms tries to increase price they wouldn't sell any products, if the price is set too low firms would fail to make normal profit and leave the industry. this explains the perfectly elastic demand curve for individuals firms products.
   • firms produce at the maximising output MC=MR at this point the firm makes supernormal profit. only achievable in the SR because in the LR new firms enter the market and compete supernormal profit away
   • productive efficiency may not be achieved because MC may not be equal to the min of AC
   • allocatively efficiency is always achieved because P=MR equal MC at the profit maximising output where P=MR, if MC=P and MC=MR then MC must =P

3. hard to find a real life example that conforms to all assumptions all markets are competitive to a degree but vast majority are imperfectly competitive.

   • A perfect competitor ensures economic efficiency - competition is good (neoclassical)

4. perfect competition in the long-run

   • new firms enter until all firms are making normal profit and include it in AC because it is necessary.
   • in the LR supernormal profit incentivises new firms to enter the market and this is possible because there are no barriers to entry/exit and the goods sold are homogenous so there is no differentiation and no single firm has price setting power they are a price taker. perfect knowledge means all firms have the same cost curves
   • new firms enter the market shown by a rightwards shift in supply this dries down the perfectly elastic price where MR3=D3=AR3=P3. AR-AC=0 where the firm produces at the profit maximising output at MC=MR at this point the firm is making normal profit. it is covering all of its costs and making normal profit. the firm cannot make more economic profit by increasing/ decreasing output as MC>MR
     • In LR where the firm produces at MC=MR productive efficiency is achieved because MC is = to the minimum of AC. Allocative efficiency is also achieved as P=MC at profit maximising output where MC=MR.

5. perfect competition with firms making a subnormal profit in the short-run

   • if for example demand decreases the equilibrium price in the market diagram decreases. as the firm is a price taker MR=D=AR=P shifts down. the firm will now produce at a new level of output and the firm is now making a subnormal profit (economic losses) fixed costs must be paid irrespective of the level of output produced. if the firm shuts down the firm must still pay these irrecoverable fixed costs.

6. the shut-down rule

   • in the SR a firm making subnormal profit will still operate as long as price is greater than AVC, otherwise, it would make a smaller loss by producing nothing and paying fixed costs only.
   • if TR > OR equal to VC carry on producing. if TR < VC stop producing, minimise subnormal profit at FC