26th NOVEMBER 2008Question onePerfect competition refers to a market in which no single seller or buyer has market power. This means that the buyers or the sellers can not fix the prices in the market because prices are determined by the forces of supply and demand. P dd ss PiQi are the prices and quantities in the market. Pi fig (a) ss dd Qi QIn the short run, such markets are allocatively inefficient as well as productively inefficient. In the long term, such markets are both productively and allocatively efficient.
In this regard a perfect competition market is characterised by the fact that no single entity or firm has got influence on the product price in the industry. Because the perfect market conditions are strict, there are few of such markets. Distinguishing characteristics of a perfect competition market include, Presence of many buyers and seller- The market has many consumers who have ability and willingness to buy products at a given price. The market has also suppliers who have the ability and willingness to bring their products into the market at a given price.
Firms are price takers. A single firm can not be able to influence the price of the products thus any amount of output can be brought to the market at the market price. This is because of the numerous numbers of firms in the market, because of products that are not differentiated and availability of information to all market participants. (Henry, 2002)Homogeneous products- The products produced by different firms are similar, for example, salt or sugar. Perfect information- Both producers and consumers have perfect information about the market Free Entry and Exit- It is relatively easy to exit and enter into the industry without restrictions or regulations.
Free exit and entry ensure that the producers in an industry can adjust to changing conditions in the market and that producers in an industry can not keep other firms out artificially. The aim of the firms is to maximize profits- The sole aim of the firms in the perfect competition market is to ensure they get higher profits by operating in a region where marginal costs meet the marginal revenue curve, that is, where they generate the highest profits.
Question twoThe usefulness of a perfect competition market to the economists can be explained both in the short run and in the long run. In the short run, a firm’s demand curve is perfectly elastic at the prevailing price. The firm can sell more or less without having any effect upon the price. To the firm, the price and the marginal revenue are equal. To recap marginal revenue is the addition to total revenue due to the sale of an additional unit of an output.
The amount of output a firm produces in the short run depends on its marginal cost and the price. Price fig (b) MC Equilibrium of the firm: price above PAC Price above average cost curve. AVC O A Qu Fig (c)