Imagine a market where there is perfect competition between two or more companie
ID: 1194821 • Letter: I
Question
Imagine a market where there is perfect competition between two or more companies, such as a fish market where vendors offer the same products at the same price or online ticket auctions like StubHub. In this market there are four key elements to perfect competition: a large number of buyers and sellers, no barriers to entry or exit, perfect mobility for customers choosing products and homogenous products.
Explain how output, price, and profit are determined in your perfectly competitive market in the long run.
How does that lead to efficiency?
How could changes in technology affect the market?
How could an increase in demand affect the market?
What are the effects of new businesses entering the market?
What are the effects of businesses leaving the market?
Explanation / Answer
A perfectly competitive market is a hypothetical market where competition is at its greatest possible level. Neo-classicaleconomists argued that perfect competition would produce the best possible outcomes for consumers, and society
The single firm takes its price from the industry, and is, consequently, referred to as a price taker. The industry is composed of all firms in the industry and the market price is where market demand is equal to market supply. Each single firm must charge this price and cannot diverge from it.
However, in the long run firms are attracted into the industry if the incumbent firms are making supernormal profits. This is because there are no barriers to entry and because there is perfect knowledge. The effect of this entry into the industry is to shift the industry supply curve to the right, which drives down price until the point where all super-normal profits are exhausted. If firms are making losses, they will leave the market as there are no exit barriers, and this will shift the industry supply to the left, which raises price and enables those left in the market to derive normal profits.