• 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.
• 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.
• 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.
• 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.
• 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
• 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