9.1- Perfect Competition
Where is long run equilibrium in a perfectly competitive market?
Long run equilibrium in a perfectly competitive markets is defined by normal profits (AR=AC) and allocative efficiency where P=MC at Q4
What is the third con of perfect competition in the long run?
The actual quality of output may not be as good as it can be
What is the second characteristic of perfect competition?
The goods and services produced are homogenous (identical)
Why might perfect competition mean the actual quality of output may not be as good as it can be?
With such intense competition and a drive to reduce costs as much as possible to survive in the long term, the actual quality of output may not be as good as it could be. This is because cost savings have to be made anywhere possible, which might imply poorer customer service and less focus on quality perks which raise the cost of production but provide the consumer greater satisfaction upon consumption
What is the first con of perfect competition in the long run?
Dynamic efficiency is not achieved in the long run
What is the fourth con of perfect competition in the long run?
A perfectly competitive market can lead to creative destruction
What are the 3 pros of perfect competition in the long run?
1) Allocative Efficiency is achieved in the long run 2) Productive efficiency is achieved in the long run 3) X efficiency is being achieved
What are 4 cons to perfect competition in the long run
1) Dynamic efficiency is not achieved in the long run 2) Product homogeneity may not be in the best interests of consumers 3) The actual quality of output may not be as good as it could be 4) A perfectly competitive market can lead to creative destruction
What are 2 ways you could evaluate the long run performance of perfect competition?
1) The idea of static v dynamic efficiency 2) The idea that firms are always dynamically Inefficient in highly competitive industries due to a lack of supernormal profit may not hold in reality
What are the 5 characteristic of perfect competition?
1) There are many (infinite) buyers and sellers 2) The goods and services produced are homogeneous (identical) 3) There are no barriers to entry or exit for firms 4) There is perfect Information/ knowledge of market conditions 5) Firms are profit maximisers and consumers are utility maximisers
How many ways could you evaluate the long run performance of perfect competition?
2
How many pros are there for perfect competition in the Long Run?
3
How many cons are there to Perfect Competition in the Long Run?
4
How many characteristics are there for Perfect Competition?
5
How might perfect competition lead to creative destruction?
A perfectly competitive market can lead to creative destruction, where supernormal profits attract new and more efficient firms into the industry. These new firms will drive out the less efficient incumbent firms who are unable to compete. Whilst this is good news for consumers who see regular price destructions over time due to the efficiency gains, existing firms shutting down will increase unemployment causing problems for the Government. This argument is weak however as the benefits of competition with new efficient firms entering a market outweigh the costs. In a market economy, loses and shutting down must be accepted as much as profits and success
What is the definition of market structure?
Characteristics of a market that determines firm behaviour
What is the fifth characteristic of perfect competition?
Firms are profit maximisers and consumers are utility maximisers
How are firms being profit maximisers and consumers being utility maximisers an characteristic of perfect competition?
Firms are profit maximisers producing where marginal cost = marginal revenue at all times and consumers are utility maximisers consuming only up until price equals their marginal utility
Tell me all about shutdown in perfect competition?
Firms who are making enough revenue to cover their variable cost of production (AR is greater than AVC) should continue producing in the short run even when losses are being made in perfect competition. This is because continuing in production will reduce total losses whereas shutting down would result in greater losses, thus moving factors of production to where they have better use is not yet the more beneficial option. By staying in production, other firms who are not covering their variable costs leave the industry, which will increase the market price allowing remaining firms to make at least normal profit or better supernormal profits in the long run. In the diagram of perfect competition, with loss and no shutdown, subnormal profits are being made at the profit maximising level of output, Q1 as AR is less than AC, indicated by the shaded rectangle. As this firm is covering its variable costs, AR is greater than AVC, it should continue to produce in the industry. This is only true for a short period, as continual losses cannot be sustained in the long run. If losses persist, even firms who are covering their average variable costs will eventually leave the industry. Firms who are not making enough revenue to cover their variable costs of production (AR is less than AVC) will shutdown when losses are being made in perfect competition. This is because continuing in production will increase total costs whereas shutting down would result in lower losses, thus moving factors of production to where they have better use is a more beneficial option. In the diagram of perfect completion, with a loss and a shutdown, subnormal profits are being made at the profit maximising level of output, Q1 as AR is less than AC, indicated by the rectangle. As this firm is not covering its variable costs, AR is also less than AVC, it should shutdown and leave the industry
How could you evaluate the point of 'Static v Dynamic Efficiency' for the long run performance of perfect competition?
Perfect Competition delivers static efficiency; consumers benefit hugely as a result as do producers where market share can rise. However dynamic efficiency is a big loss along with product homogeneity. A case could be made that consumers may be willing to lose some static efficiency benefits, instead paying slightly higher prices in return for differentiated goods and innovative new product developments over time
Why might Perfect Competition making products homogenous not be in the best interests of consumers?
Product homogeneity is not in the best interests of consumers who prefer variety rather than having a large number of different sellers all producing the same good or service. This is where allocative efficiency might not actually maximise the benefit to consumers
What is the second con of perfect competition in the long run?
Product homogeneity may not be in the best interests
How is goods and services produced being homogenous is an characteristic of perfect competition?
The goods and services produced are homogenous (identical) . This makes firms price takers, taking the price set by the market, they have no influence at all in setting prices with no differentiation between products. If firms raised their price, they would lose all their consumers and if firms reduce their price, either all firms would follow immediately reducing revenues or revenues will not cover costs leading to losses that can't be sustained
Explain fully the perfect competition diagram with short run supernormal profit?
The market equilibrium price is at P1. Taking this price firm will profit maximise where MC=MR producing Q2 units of output. At this level of production, AR is greater than AC, thus the firm is making supernormal profits Indictated by the shaded rectangle. Firms are attracted into the industry by the supernormal profits and with no barriers to entry, the supply curve shifts to the right from S1 to S2 thus the market equilibrium price falls. This process continues from P1 to P2 until the demand (AR) curve, for an individual firm, is tangential to the AC curve, where normal profit is being made and the firm has returned to a long run stable equilibrium at Q4
Explain fully the perfect competition diagram with short run supernormal loss?
The market equilibrium price is at P1. Taking this price, firms will profit maximise where MC=MR producing Q2 units of output. At this level of production, AR is less than AC, thus the firm is making subnormal profit (economic losses) indicated by the rectangle. Firms who are not covering their average variable cost of production will shutdown and leave the industry to minimise their losses immediately given no barriers to entry, thus the supply curve shifts to the left from S1 to S2 increasing market equilibrium price. This process continues from P1 to P2 until the demand (AR) curve, for an individual firm, is tangential to the AC curve, where normal profits is being made and the firm has returned to a long run stable equilibrium at Q4
How could you evaluate the point of 'firms are always dynamically Inefficient in highly competitive industries due to a lack of supernormal profit in the long run' may not hold in reality?
The notion that firms are always dynamically inefficient in highly competitive industries due to a lack of supernormal profit in the long run may not hold in reality. Firms may be forced to re-invest whatever profits they are making (even normal profits) in order to stay ahead of rivals and compete in such as fiercely competitive market. This will also be in the long term interests of firms as it gives them an element of monopoly power which they can exploit to increase profits over time
What is the first characteristic of perfect competition?
There are many (infinite) buyers and sellers in a market
How is there being many buyers and sellers in a market an characteristic of perfect competition?
There are many (infinite) buyers and sellers in a perfectly competitive market. The concentration ratio is 0 where firms must compete with each other in order to survive in the market place
How are there being no barriers to entry or exit for firms is an characteristic of perfect competition?
There are no barriers to entry or exit for firms, meaning entry and exit is completely costless. If firms are attracted by supernormal profits they can enter straight away and if firms want to leave due to losses being made, they can do so immediately. This implies that short run supernormal or subnormal profit will not be sustained in the long run
What is the third characteristic of perfect competition?
There are no barriers to entry or exit for the firm
What is the fourth characteristic of perfect competition?
There is perfect information/knowledge of market conditions
How are there being perfect information/knowledge of market condition an characteristic of perfect competition?
There is perfect information/knowledge of market conditions for both consumers and producers. For consumers they have perfect information over prices being charged and producers have perfect information over costs and technology in the industry as well as prices being charged
How might perfect competition lead to productive efficiency being achieved in the long run?
This is because Perfectly Competitive firms produce at the lowest point of the average cost curve, where MC=AC at the long run equilibrium point of production. This means all possible economies of scale are being fully exploited as firms cannot increase output and lower their average cost any further. These lower average costs can translate into lower prices for the consumers increasing their consumer surplus. For the producer, lower average costs can lead to higher levels of supernormal profits over time and increases in market share if economies of scale benefits translate into lower prices than rivals. Perfectly competitive firms must be allocative efficient otherwise they will lose their market share to rivals who are doing so
How might perfect competition lead to allocative efficiency being achieved in the long run?
This is because firms in perfect competition produce where P=MC at the long run equilibrium point of production. This is where demand equals supply maximising the sum of both consumer and producer surplus which a key feature of a highly competitive industry. At this point of production, resources are allocated according to consumer demand with consumers getting what they demand at the exact quantity they desire. Consumer choice is high and prices are low maximising consumer surplus in the market. The quality of the product sold too is excellent given the drive to meet the needs and wants of the consumer. Producers benefit from being allocatively efficiency by getting ahead of rivals who are not meeting consumer wants and needs as well thus increasing their market share. Overtime this can result in higher profits for the business. Perfectly competitive firms must be allocatively efficient otherwise they will lose market share to rivals who are doing so
How might perfect competition lead to x efficiency being achieved?
This is because perfectly competitive firms are producing on the average cost curve at the long run equilibrium output level. In this sense firms are minimising their unit costs implying there is no waste in production. For highly competitive firms, being X-Efficient is crucial to charge the lowest prices for consumers increasing their consumer surplus For the producer, lower average costs can lead to higher levels of supernormal profit over time and also increases in market share if lower prices are charged compared to rival firms. Perfectly competitive firms must be X-Efficient otherwise they will lose their market share to rivals who do so
Why might perfect competition not lead to dynamic efficiency in the long run?
This is because supernormal profits are not being made in the long run thus restricting a firms ability to re-invest back into the business. Over time consumers lose out with no technology advances or innovative new products reducing their choice and also preventing price falls in the future. For producers, their profit making potential reduces without R and D and new product launches which could have been patentable providing monopoly power. New products could have increased market share, crucial in such a competitive industry where the only way to get ahead of rivals is through innovation and R and D. Once more, better technology could have allowed a firm to reduce costs of production and thus become more profitable over time