Skip to main content

3.4.2 Perfect competition

Perfect competition 

Assumptions of perfect competition 

1. All firms produce homogenous products. All products are perfect substitutes for each other - meaning a perfectly elastic demand curve. 
2. All firms are profit maximisers (MC = MR)
3. There are no barriers to entry or exit. Firms can move into and out of the market freely. 
4. There is perfect information between firms, between consumers and between firms. 
5. There is a large number of buyers and sellers - each firm is a 'price taker' 
(6. All factors of production are perfectly mobile - perfect geographical and occupational mobility) 
(7. No externalities) 

Characteristics

Firms are price takers 

AR = MR 

Due to products being homogenous, there is a high number of substitutes and so the demand curve is perfectly elastic. 


Normal profits are made 

AR = AC 

Due to there being no barriers to entry or exit, firms can only make normal profits in the LR. 
Image result for perfect competition

In the SR, supernormal profits may be made, but as there are no barriers to entry, firms will move into the market, and market supply will shift out. This will decrease each individual firms' demand, and the AR curve will shift downwards. A new equilibrium will be reached at a lower price and output - where AR = AC once again, and normal profits are attained. 

Supernormal losses may also occur in the SR, but the opposite will happen (firms move out of market, individual demand shifts up, price increases, firms make normal profit). 


Both productive and allocative efficiency are attained 

In the LR,

AR = MR (price takers) 

MR = MC (profit maximisers), therefore... 


In the LR firms must operate at the bottom of the AC curve (due to the various conditions as above). As output is at the minimum of the AC curve, the lowest cost per unit is achieved and productive efficiency is attained. 


Labels:

Comments

Post a Comment

Popular posts from this blog

Output gaps and the business cycle

Output gaps and the business cycle The fluctuation of real GDP around an underlying trend is a phenomenon known as the business cycle.  Output gap  - difference between the actual output of an economy and its potential output.  There are two types of output gap, trend and  potential.  Trend growth is the estimated rate of growth of an economy.  Trend output gaps:  Business cycle diagram A negative trend output gap is when real GDP is below trend GDP. The economy is producing below its trend.  e.g If real GDP is £1.8 trillion and trend GDP is £2 trillion then the negative output gap is £0.2 trillion.  Here the economy is in a bust  period. This is characterised by an expansion in GDP, high employment and high confidence. Price levels often rise, meaning inflation occurs.  A positive trend output gap is when real GDP is above trend GDP.  Here the economy is in a recession  (bust). This is characterised by a contraction in GDP, high unemployment and lo
Post a Comment
Read more

3.1.3 Demergers

Demergers   A demerger is the breaking up of a firm into separate firms.  e.g Sports Direct selling off Dunlop in 2016. PepsiCo splitting off foods businesses (KFC, Taco Bell, etc.) into a separate corporation, Yum Brands. Later Yum Brands demerged into Yum China and Yum Brands. Reasons for demergers Diseconomies of scale - the opposite of economies of scale, where average costs begin to rise as output increases. May occur due to it being difficult to retain control on the expanding business - principal-agent problem may arise. Also less co-operation by employees who feel more alienated and as a result less productive - they feel less of a connection to the business.  May also be hard to co-ordinate and communicate between locations and employees when a firm is large. Miscommunication can again lead to costs rising.  To focus on core businesses to streamline costs and improve profits. The firm may have expanded into different markets and experience disadvantages due to t
Post a Comment
Read more

3.4.1 Efficiency

Efficiency   Allocative efficiency  Output at which the marginal utility, or benefit, of a good to a consumer is the same as equal to the marginal cost of producing it.  This is seen on demand/supply curves, where D = S, output is produced as demand = marginal utility and supply = the sum of firms' marginal costs in an industry. On an individual scale, it is where:  AR = MC  Output is where the demand curve cuts the MC curve.   NB: technically occurs where MSB = MSC (if you consider externalities)  Occurs in perfect competition.  Eval - PC markets achieve allocative efficiency where there are no externalities.  LR equilibrium is where P = MPC, so if MSC > MPC, then there is an allocative inefficiency which leads to overproduction and consumption.  Productive efficiency  Output at which a good is produced at the  lowest possible average cost for a firm. This occurs at the minimum point of the AC curve.  AC = MC at this point, because w
Post a Comment
Read more