This topic the principles which guide firms in their price and quantity decisions will be set out in the short and long run. Perfect competition is defined. The demand and marginal revenue are derived. The equivalence between profit maximization and equality of marginal revenue and marginal cost is established. The long run equilibrium is studied. The economic effect of this market form is shown to be optimum for society.
Definition:
Theoretical free-market situation where (1) buyers and sellersdegree of individualcontrol over prices, (2) all buyers and sellers seek to maximize their profit (income), (3) buyers and seller can freely enter or leave the market, (4) all buyers and sellers have access to information regarding availability, prices, and quality of goodshomogeneous, hence substitutable for one another. Also called perfect market or pure competition.
introduction:
A perfectly competitive industry is highly unlikely to exist in its entirety given the strong assumptions made about the operation of the market.All markets are “competitive” to one degree or another, but the vast majority of markets are characterised as “imperfectly competitive”. We do, though get closer to perfect competition in many markets for agricultural and other primary commodities. These are the only markets where there are enough sellers of products that are near perfect substitutes for each other.
Main Assumptions of Perfect Competition
• Each firm produces only a small percentage of total market output. It therefore exercises no control over the market price. For example it cannot restrict output in the hope of forcing up the existing market price. Market supply is the sum of the outputs of each of the firms in the industry
• No individual buyer has any control over the market price - there is no monopsony power. The market demand curve is the sum of each individual consumer’s demand curve – essentially buyers are in the background, exerting no influence at all on market price.
• Buyers and sellers must regard the market price as beyond their control.
• There is perfect freedom of entry and exit from the industry. Firms face no sunk costs that might impede movement in and out of the market. This important assumption ensures all firms make normal profits in the long run.
• Firms in the market produce homogeneous products that are perfect substitutes for each other. This leads to each firms being price takers and facing a perfectly elastic demand curve for their product.
• Perfect knowledge – consumers have perfect information about prices and products.
• There are no externalities which lie outside the market.
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