Perfect competition

Definition: Perfect competition is a theoretical market structure. It is primarily used as a benchmark against which other market structures are compared. The industry that best reflects perfect competition in real life is the agricultural industry.

Characteristics:

• Homogenous products - goods made by different firms but which are identical.
• Perfect knowledge - consumers and producers are aware of what is being offered to the market.
• Large number of firms in competition with each other.
• Large number of buyers and sellers
• Each firm can sell as much as it wants to produce - Demand curve is perfectly elastic = AR
• Freedom of market entry and exit - e.g. little machinery required, low start up costs.
• Short run supernormal profit only.

Definition: Perfect competition is a theoretical market structure. It is primarily used as a benchmark against which other market structures are compared. The industry that best reflects perfect competition in real life is the agricultural industry.

Characteristics:

• Homogenous products - goods made by different firms but which are identical.
• Perfect knowledge - consumers and producers are aware of what is being offered to the market.
• Large number of firms in competition with each other.
• Large number of buyers and sellers
• Each firm can sell as much as it wants to produce - Demand curve is perfectly elastic = AR
• Freedom of market entry and exit - e.g. little machinery required, low start up costs.
• Short run supernormal profit only.

• Freedom of entry means that only normal profit will be made in the long run. This is because short term supernormal profits will attract new firms into the market and erode profits. As new firms enter the market, the supply curve for the industry shifts rightward, meaning that the price level drops and similarly the AR=MR=D curve for individual firms falls to accomodate for the change in price
• If in the short run losses were experienced, firms would leave the industry and long run equilibrium would be restored by a subquent rise in prices.
• In the short run, firms continue to enter or leave the industry until normal profits are made, at which there is no further incentive to enter of leave the industry.
• Point of rest as this is the long run
• This is where there is normal profit. This is not a bad thing as wages are still taken into account.
• AC = AR
• HOWEVER THERE IS NO SUCH THING AS A PERFECT MARKET.

Advantages of perfect competition: 1) everyone is being paid, 2) allocatively and productively efficient, 3) government tax revenue is high, 4) consumers get the lowest price 6) hit and run profits - enter and leave

• Firms have to accept the price determined at industry level and then supply the quantity of output that will maximise the firm's profits.
• In the short run it is possible to make supernormal profits.
• However, the output produced is not at minimum possible average cost in the short run, i.e. it is not productively efficient.

Supply curve:

• In the short run the supply curve is therefore the marginal cost curve above the average variable cost. At this level of output, when the marginal revenue crosses the marginal cost, the firm will remain open as it makes a contribution towards fixed costs.

Shut-down point:

• This occurs when a perfectly competitive firm is not coverage average variable costs in the short run. i.e. it may be feasible for a firm to make a loss in the short run, as long as it covers the cost of making the good and therefore makes a contribution to the fixed costs.
• For example, if the fixed costs for producing a good are £100,000, then closing the firm will induce costs of £100,000, whereas keeping the firm open will only make a loss of £70,000, therefore the firm will not shut down.