Study Notes
Perfect competition is a market structure where many small firms sell identical products, and no single firm has market power. Firms in perfect competition are price takers and achieve allocative efficiency in the long run.
- Perfect Competition — a market structure with many small firms selling identical products and no barriers to entry. Example: International agricultural commodities markets.
- Market Power — the ability of a firm to control the price of its product. Example: Firms in perfect competition have no market power.
- Allocative Efficiency — a state where resources are distributed in a way that maximizes social surplus. Example: Achieved in perfect competition when P = MC.
- Normal Profit — the minimum profit necessary for a firm to continue operating in the long run. Example: Occurs when total revenue equals total costs (TR = TC).
- Abnormal Profit — profit above the normal profit level. Example: Occurs in the short run when price per unit is higher than average cost (P > AC).
Exam Tips
Key Definitions to Remember
- Perfect Competition
- Market Power
- Allocative Efficiency
- Normal Profit
- Abnormal Profit
Common Confusions
- Confusing perfect competition with monopolistic competition.
- Misunderstanding the concept of price takers.
Typical Exam Questions
- What is perfect competition? A market structure with many small firms selling identical products and no market power.
- How do firms in perfect competition achieve allocative efficiency? By producing where price equals marginal cost (P = MC).
- Why do firms in perfect competition only earn normal profits in the long run? Because any abnormal profits attract new firms, increasing supply and lowering prices.
What Examiners Usually Test
- Characteristics and examples of perfect competition.
- The concept of firms as price takers.
- The conditions for allocative efficiency and normal profit in perfect competition.