Perfect Competition

Features of Perfect Competition

1. Many Firms

2. Freedom of Entry and Exit, this will require low sunk costs

3. All firms produce an identical or homogenous product

4. All firms are price takers, Therefore firm’s demand curve is perfectly elastic

5. Perfect information and knowledge

These factors are unrealistic in the real world. However Perfect Competition is as important economic model to compare other models it is often argued that competitive markets have many benefits this model can be used to back this up.

· In the Industry price is determined by the interaction of Supply and Demand

· The firm will maximise output where MR = MC

· In the Long Run Firms will make Normal profits.

If Supernormal profits are made new firms will be attracted into the industry causing prices to fall. If firms are making a loss then firms will leace the industry causing price to rise

Changes in Long Run Equilibrium

1. The Effect of an Increase in Demand for the Industry.
If there is an increase in demand there will be an increase in price Therefore the Demand curve and hence AR will shift upwards. This will cause firms to make supernormal profits
This will attract new firms into the market causing price to fall back to the equilibrium of Pe

2. An increase in firms costs
The AC curve will increase therefore AR< AC
Firms will now start making a loss and therefore firms will go out of business. This will cause supply to fall causing prices to increase

 

Essays and Revision Notes on Market Structure

• Perfect Competition

• Efficiency of Perfect Competition

• Monopolies

• Monopoly Diagram

• Advantages of Monopoly

Do Competitive Markets promote innovation?