|
|
Revision:Perfect competitionTSR Wiki > Study Help > Subjects and Revision > Revision Notes > Economics > Perfect competition Perfect competition is a model of a market structure where allocative and productive efficiency are achieved (long run). A number of assumptions are made:
Perfect competition graphicallyIn perfect competition, firms are price takers. If they charged a price other than the market price they would either:
Therefore the firm's demand curve is horizontal and equal to the market price. Short runIf the market price is set above or below the costs of the firm, the firm may make profits or losses. The firm produces at the output solution point (MR = MC). If the costs are lower than this, the firm makes a profit. Allocative efficiency is achieved because AR=MC. Productive efficiency is not achieved because AC does not equal MC at the output solution point.
The reverse is also true: a firm which has costs higher than the market price will make a loss. Again, allocative efficiency is achieved. Productive efficiency is not.
Long runIf firms in the short run are making profits, there are incentives for new firms to enter the market. This will increase market supply, causing market price to drop and the profit of incumbent firms to be eroded. This can occur because there are no barriers to entry. The price will drop to the point where productive efficiency is achieved.
Evaluation of perfect competitionPerfect competition is merely a theoretical ideal. However, the model can still be useful even if it's not realistic.
The model of perfect competition is most applicable in markets such as
Even these markets do not fit the model perfectly. Think of the impact of big supermarket monopsony power and transaction costs in agricultural markets, and the possible barriers to entry in trading currency. Comments |