2. • In perfect competition all firms
are too small to have any
market power and so they will
act as "price-takers" and simply
charge the market price P1.
• For an industry to be perfectly
competitive, there must be
freedom of entry and exit, all
firms must be price-
takers, there must be perfect
information, perfect mobility of
factors and the products must
be homogenous.

3. • In the short run a firm in perfect
competition may make
supernormal profit. In this case
there is a supernormal profit of
£2,300.
• The firm will produce where
marginal cost is equal to marginal
revenue. This occurs at an output
level of 100 units in the diagram.
The supernormal profit on each
unit is £23. This is the difference
between the average revenue
(£100) and the average cost (£77).
The total profit will be the profit
per unit times the number of
units.

4. • If firms in perfect competition are
making below normal profit, then
some firms will tend to leave the
industry, prices will rise and normal
profits will be restored.
• Normal profit is the level of profit
required to keep a firm in the
industry. At a price of P1 average
cost is above average revenue and
so the firm is making below normal
profit. Some firms will therefore
leave the industry, supply in the
market will fall and prices will rise.
This process ends at a price of P2
where normal profits are restored
and the industry is in long run
equilibrium.

5. • long run equilibrium in
perfect competition
occurs where marginal
cost, marginal revenue,
average cost and average
revenue are all equal.
• In long run equilibrium in
perfect competition there
will be the optimum
levels of allocative and
productive efficiency and
there will simply be
normal profit.

6. • This occurs when the
maximum number of
goods and services are
produced with a given
amount of inputs. This will
occur on the production
possibility frontier. On the
curve it is impossible to
produce more goods
without producing less
services. Productive
efficiency will also occur at
the lowest point on the
firms average costs curve
MC=AC

7. • This occurs when goods and
services are distributed
according to consumer
preferences. An economy
could be productively
efficient but produce goods
people don’t need this
would be allocative
inefficient.
Allocative efficiency occurs
when the price of the good
= the MC of production
MC=AR