2. Assumptions underlying the theory of Perfect
Competition
There are many buyers in the industry
No individual buyer can influence, by his/her own actions the market
price of the goods
Each individual firm is price taker
Each individual buyer acts independently
There are many sellers in the industry
No individual seller can influence, by his/her own actions the market
price of the goods
Each individual firm is a price taker
Each individual seller acts independently
3. The goods are homogenous
The goods, which are supplied by the producers, are exactly the
same/identical
Thus it pointless for the firms to advertise
There is freedom of entry to and exit from the industry
Firms already in the industry cannot prevent new firms from entering
the industry
No barriers to entry exist within the industry
Perfect knowledge as to profits and prices
In the market everyone concerned has perfect knowledge as to profits
made by other firms in the industry
Consumers are fully aware of the prices being charged for the products
Each firm tries to maximise profits
The aim of each firm is to produce that quantity where MC = MR
4. Firms face a perfectly elastic supply of factors of production
If a firm wants to increase output it can do so and acquire the
necessary f.o.p’s at the existing price I.e. a scarcity of f.o.p’s will not
develop thereby pushing up their price
No collusion exists on the market
No collusion exists between buyers of the good or sellers of the good.
Buyers do not group together with other buyers and sellers do no
group together with other sellers in order to influence the price at
which the good is sold
5. Explain the concept of a price taker
This means that the individual firm must accept the
price as it is set on the market. Each firm
supplies such a tiny fraction of the market it
cannot influence the market price
6. Shor t Run Perfect Competition diagram
P
MC
AC
P1 E AR = MR = D
Q1 Q
7. Short run perfect competition explanation
Equilibrium occurs at Practice your
point _, where MC = MR diagram here..
and MC is rising
Price/ output
The firm produces output
Q1
The firm sells at price P1
Profits
The firm is earning SNP’s
I.e. AR>AC
Costs
The firm’s costs are at point
_
8. Impact which the entry of new firms will
have on the market
S1 S2
Due to perfect knowledge
P of profits and the freedom
of entry and exit in the
market, new firms enter the
market.
P1 The supply curve for the
market shifts to the right from
S1 to S2 and the market
P2 price falls.
Firms will now produce a
smaller quantity.
D Amount of SNP’s will fall/ be
Q eliminated
9. Long Run Perfect Competition diagram
P
MC
AC
P1 AR = MR = D
P2 AR = MR = D
E
Q2 Q
10. Long run equilibrium in Perfect Competition
Practice your LR diagram.. And fill in the blanks
Equilibrium occurs at
__, where _________
Price/output: The firm
produces output __ and
sells at price ___
Profits: The firm is
making normal profit
where AR __AC
Costs: The firms costs are
at point _, most efficient
point on the AC curve.
11. Firms in PC tend not to engage in advertising
because of:
Homogeneous goods
Because the goods are identical, and no differences exist, then there
is no point in advertising
Increased costs/no additional revenue
If a firm did advertise it would increase its own costs and decrease is
profits.. It would gain no additional revenue for itself
Benefits the entire industry
Advertising by a single firm would not just benefit this firm but the
entire industry
12. Supply curve of a firm in perfect competition
short run
P Theshort run supply
MC curve of a firm in perfect
competition is that part
AVC of the marginal cost
curve above AVC
Q
13. Supply curve of a firm in perfect competition
long run
P The long run supply
MC curve of a firm in perfect
competition is that part
AC of the marginal cost
curve above AC
Q
14. Why does perfect competition benefit
consumers?
Consumers pay the lowest price for the good since
the firm produces at the minimum price on the
average cost curve
Maximum efficiency: lowest point on the AC curve
No SNP’s exist in the long run
No competitive advertising undertaken in perfect
competition
15. Why does perfect competition benefit the
economy?
Only the most efficient firms survive, since any firms
whose costs are such that AC>AR will be forced out
of the industry in the long run. It must use its
resources efficiently
No barriers to entry exist which could have the effect
of reducing competition or distorting the market
