perfect-competition

Characteristics of Perfect Competition

• The characteristics of perfect competition are as follows:

1. There are many buyers and sellers: due to the number of market participants, sellers are price takers

2. There are no barriers to entry and exit from the industry: firms can start-up or leave the industry with relative ease, which increases the level of competition

3. Buyers and sellers possess perfect knowledge of prices: this assumption presupposes perfect information, e.g if one seller lowers their price, then all buyers will know about it

4. The products are homogenous: this means firms are unable to build brand loyalty as perfect substitutes exist and any price changes will result in losing all customers. Demand is therefore perfectly price elastic

Profit Maximising Equilibrium in the Short and Long-run

• In order to maximise profit, firms in perfect competition produce up to the level of output where marginal cost = marginal revenue (MC=MR)

• The firm does not have any market power so it is unable to influence the price and quantity

  • The firm is a price taker due to the large number of sellers

  • The firm’s selling price is the same as the market price, P₁ = MR = AR = Demand

• In the short-run, firms can make supernormal profit or losses in perfect competition

• However, they will always return to the long-run equilibrium where they make normal profit

Perfect Competition Diagrams

Short-run profit maximisation

• Firms in perfect competition are able to make supernormal profit in the short-run

• The MC curve is the supply curve of the firm

Diagram analysis

• The firms is producing at the profit maximisation level of output where MC=MR (Q₁)

  • At this point the AR (P₁) > AC (C₁)

  • The firm is making supernormal profit

Short-run losses

• Firms in perfect competition are able to make losses in the short-run