Competitive Markets

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  • Created by: Ellie
  • Created on: 02-04-15 09:30
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  • Competitive Markets
    • The Model of Perfect Competition
      • The Conditions of Perfect Competition
        • A large number of buyers and sellers
        • Perfect information about what is going on in the market
        • Firms are able to sell as much as they wish to at the ruling market price
        • Independent actions by firms will not influence the ruling market price
        • A uniform, identical or homogeneous product
        • Complete freedom for firms to enter or leave the market but only in the long run
      • How Much Should a firm produce?
        • Firms decided on their output based on the fact that profit maximisation is where MC=MR
        • Total Revenue= price x Output
        • Total Cost = Average Total Cost x Output
        • Profit = Total Revenue - Total Cost
      • Perfect Competition in the Short Run
        • Each Firm in a perfectly competitive market passively accepts the ruling market price. This becomes a firms average revenue and marginal revenue curve
        • If a firms ATC were above the AR=MR line then the firm would be making a loss
        • Perfectly Competitive firms make supernormal profits in the short run but the short run equilibrium only lasts as long as new entrants are kept out of the market.
        • Perfectly competitive firms can make losses in the short run when the firms average total  cost is below the point of profit maximisation
      • Perfect Competition in the Long Run
        • When firms have supernormal profits in the short run, the ruling market price signals to firms outside the market that supernormal profits can be made incentivising them to join the market.
        • The entry of new firms causes profits to decrease until the firms are only making normal profit
        • This normal profit means there are no incentives to enter or leave the market
      • Perfect Competition Revenue Curves
        • The perfectly competitive firm faces a perfectly elastic demand curve for its product. Firms in perfect competition have no influence over the market.
        • Perfectly competitive firms are known as passive price takers
        • If a firm raises its selling price above the ruling market price there would be cheaper perfect substitute goods
        • If a firm sells its output below the ruling market price it wouldn't be making normal profit and therefore make a loss.
      • How Useful is Perfect Competition?
        • Perfect Competition is not meant to reflect the real world markets where many of the assumptions aren't satisfied.
        • Normal competitive behaviour like advertising and price wars isn't possible in perfect competition
        • Whilst there are an infinite number of sellers in perfect competitions every firm sells identical goods so consumers only have a choice of where they buy from not what they buy.
        • It is not dynamically efficient as there is no incentive for firms to carry out R&D due to there being perfect information in the market.
        • It is a useful comparison for imperfect competition
      • Perfect Competition in Reality
        • It is very difficult to find examples of perfect competition in reality
        • Foreign exchange dealing: many buyers and sellers, homogeneous product, small traders relative to market
        • Agricultural markets and eBay are other examples
      • When will firms decide to leave the industry
        • When a firm is making a loss whilst it might be producing at a point of profit maximisation its not using is resources efficiently
        • The decision of a firm leaving the industry quickly or over a period of time depends on the relationship between price and average variable cost.
        • In the short run firms can continue in production with out covering all of its fixed costs but these costs must be paid in the long run
        • If the price is above the AVC the firm should continue in production during the short term in order to offset some of the fixed costs. It should shut down slowly.
        • If the price falls below the AVC there is no point in continuing to produce and the firm should shut down immediately.
    • Competition and the Efficient Allocation of Resources
      • Efficiency
        • Technical Efficiency
          • A process is technically efficient if it maximises output produced from the available factors of production
          • At any level of output production is technically efficient if it minimises the inputs of capital and labour needed to produce that level of output
        • Productive/Cost efficiency
          • Productive efficiency is when a firm minimises the average costs of production
          • In the short run the lowest point on the SRATC curve shows the most productively efficient level of output
          • Productive efficiency is more long run than short run and is shown by the lowest point on the LRAC curve
          • Any point that lies on the PPF is technically and productively efficient
        • X-efficiency
          • X inefficiency is when there is organisational slack (spare capacity)
          • A firm must be technically inefficient to be x inefficient also it is caused by over paying its workers
        • Allocative Efficiency
          • This occurs when P=MC in all industries and markets in the economy.
          • It occurs when it is impossible to improve overall economic welfare by reallocating resources between industries and markets.
          • When P>MC households pay a price for the last unit which is greater than the cost of producing the last unit of goods.
        • Dynamic Efficiency
          • This measures the extent to which various firms of static efficiency improve over time
          • Improvements in dynamic efficiency result from the introduction of better methods of producing existing products like invention innovation and R&D
        • Static Efficiency
          • This Measures technical, productive, X and allocative efficiency at a particular point in time
        • Economic efficiency minimises costs incurred with minimum undesired side effects.
      • Monopoly and Economic Efficiency
        • A monopoly is both productively and allocatively inefficient
        • It is X inefficient as it incurs unnecessary production costs above the average cost curve.
        • Monopolists can be dynamically efficient as supernormal profits allow them to invest into R&d but there is a lack of incentive due to barriers to entry
      • Perfect Competition and Economic Efficiency
        • A perfectly competitive firm is both productively and allocatively efficient.
        • It is X efficient, a firm has to be x efficient in order to make normal profits in the long run
      • Benefits of Perfect Competition
        • Competition drives an improvement in welfare and efficiency
        • Competition drives under performing firms out of the market and shifts market share to more efficient firms in the long run
        • It encourages firms to innovate and adopt best practice techniques. Firms will strive to improve products, reduce costs and improve quality of products

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