Study Notes
Perfect competition is a market structure where many small firms sell identical products, and no single firm can influence the market price. Firms in perfect competition are price takers and achieve allocative efficiency in the long run.
- Perfect Competition — a market structure with many small firms, identical products, and no barriers to entry. Example: International agricultural commodities markets.
- Market Power — the ability of a firm to influence the price of its product. Example: Firms in perfect competition have no market power.
- Allocative Efficiency — occurs when resources are distributed in a way that maximizes consumer and producer surplus. Example: Achieved in perfect competition when P = MC.
- Normal Profit — the minimum profit necessary for a firm to stay in business in the long run. Example: Occurs when total revenue equals total costs (TR = TC).
- Abnormal Profit — profit above the normal level, occurring in the short run. Example: When total revenue is greater than total costs (TR > TC).
Exam Tips
Key Definitions to Remember
- Perfect Competition
- Market Power
- Allocative Efficiency
- Normal Profit
- Abnormal Profit
Common Confusions
- Confusing normal profit with zero profit
- Misunderstanding that firms in perfect competition can make abnormal profits in the long run
Typical Exam Questions
- What is perfect competition? A market structure with many small firms, identical products, and no barriers to entry.
- How do firms in perfect competition achieve allocative efficiency? By producing where price equals marginal cost (P = MC).
- Why can't firms in perfect competition make abnormal profits in the long run? Because new firms enter the market, driving profits down to normal levels.
What Examiners Usually Test
- Characteristics of perfect competition
- Differences between short-run and long-run profits in perfect competition
- The concept of allocative efficiency and how it is achieved