Aspects of Perfect CompetitionA2 Microeconomics - Tutor2u

Assumptions of a Perfectly Competitive Market

Racecourse bookmakers Street Markets

Each firm too small to affect price via a change in supply

Homogeneous products that are perfect substitutes for each other

Consumers have complete information about prices

Transactions between buyers and sellers are costless

All industry participants and new entrants have equal access to resources

No barriers to entry & exit of firms in the long run

A price taker

How close are these markets to perfect competition?

Many firmsTransactions ‘costless’

Products not homogenous (different

odds)

Many firms‘Homogenous’ product

Some barriers to setting up stall

16

Perfect Competition

Price, Cost

Output

Price, Cost

Output

17

Perfect Competition: The Market and Individual Firms

Price, Cost

Output

Price, Cost

Output

Market Supply and Demand

Revenues, Costs and Profits for a Competitive Firm

MD

MS

AC

MC

P P = AR = MR

Q Q

Abnormal profits

17

Long Run Equilibrium under Perfect Competition

Price, Cost

Output

Price, Cost

Output

Market Supply and Demand

Revenues, Costs and Profits for a Competitive Firm

D

S

AC

MC

P1= AR1 = MR1

S1

P1

Q1 Q1

Normal profits

17

Does Perfect Competition lead to economic efficiency?

Cost & Price

Output (Q)

Perfectly Competitive Market

S1

D1

P1

P2

Entry of new firms

drives market

price lower

MC

AC

S2

Allocative Efficiency

The value consumers place on a good or service equals the cost of the resources used up in production

Productive Efficiency

When the output is produced at minimum average total cost

Dynamic Efficiency

The productive efficiency of a firm over a period of time.18

Does Perfect Competition lead to economic efficiency?

Cost & Price

Output (Q)

Perfectly Competitive Market

S1

D1

P1

P2

Entry of new firms

drives market

price lower

MC

AC

S2

Allocative Efficiency

In the long and short run price is equal to MC – therefore allocatively efficient

Productive Efficiency

In the long run, price is at lowest possible AC, therefore productively efficient

Dynamic Efficiency

Without drive to innovate products, the dynamic efficiency in competitive markets is low.18

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