Perfect Competition

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Perfect Competition

Theoretical

Conditions for perfectly competitive market:

infinite number of suppliers and consumers - small enough that no single firm has market power and firms are price takers

consumers have perfect information - well informed decisions as consumers know how much every for charges for their product

Producers have perfect information- no secret low cost production methods

Products are identical- switch between products from different firms

No barriers to entry and no barriers to exit

Firms are profit maximisers- decisions that firm makes are geared towards maximising profits

Conditions for a perfectly competitive market ensure rationing, signalling and incentive functions of price mechanism work perfectly.

Firms are price takers

Consumers and producers have perfect knowledge of the market and no barriers to entry and exit

A market demand curve=marginal utility because consumer demand reflects what that good is worth to them

Allocative efficiency occurs when a goods price is equal to what consumers want to pay for it. Happens in perfectly competitive market because price mechanism ensures that producers supply exactly what consumers demand.

Perfect competition, no firm will make supernormal profits in the long run

Any short term supernormal profits attract new firms to the market and supernormal profits are competed away. This is easy to do as there is no barriers to entry.

If market price (AR) falls below a firms average unit cost(AC), firm is making less than normal profit

In long run, will just leave the market

Short run possibilities:

If selling price AR is above firms average variable costs(AVC) then firm may continue to trade temporarily

If selling price AR falls below the level of average variable costs, then it will leave market immediately

Productive efficiency is about ensuring the costs of production are as low as possible- consumer prices are low as well .

Perfect competition,productie efficiency comes as a result of firms trying to maximise their profits

Marginal Revenue= Marginal costs

If output above this level (MC>MR)it reduces their profit - firms wouldnt produce it

Output below this level (MR>MC) mean that firm would earn more revenue from extra outpit

Having to compete gives firms strong incentive to reduce waste and inefficiency.

KEEP X-EFFICIENCY DOWN

X-EFFICIENCY- a measurement of how successful firms are at keeping their costs down. Production costs could be reduced at that level of production. Can be caused by using factors of production in a wasteful way or by paying too much for factors of production

Perfectly competitive markets only able to achieve productive efficiency is theres no economies of scale in the industry

This is usually not the case as:

- Infinite numbers of firm

-each firm very small and cant take the advantage of economies of scale

- If economies of scale exist in perfectly competitively industry then to may be more productively efficient for one big firm to exist

Perfect competition doesn't lead to dynamic efficiency

Firms in perfectly competitive market can only earn normal profit- no reward for risk taking

As long as market is towards perfect completion end- firms can achieve a degree of dynamic efficiency without being too allocatively and productively inefficient.

There is static efficiency

Allocative and productive efficiency achieved at a particular point- static efficiency . Doesn't last forever as technology and consumer preferences change

To remain allocatively & productively efficient, makers would need to invest in new production technology

Perfectly competitive market, all goods are identical and firms compete on price

In reality- firms compete in other ways - improve products, better quality of service, packaging,wider product ranges, advertising