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Table of Contents

  1. Topic pack - Microeconomics - introduction
  2. 1.1 Competitive Markets: Demand and Supply
  3. 1.1 Competitive Markets: Demand and Supply - notes
  4. 1.1 Competitive markets - questions
  5. 1.1 Competitive markets - simulations and activities
  6. 1.2 Elasticities
  7. 1.2 Elasticities - notes
  8. Section 1.2 Elasticities - questions
  9. Section 1.2 Elasticities - simulations and activities
  10. 1.3 Government intervention
  11. 1.3 Government Intervention - notes
  12. 1.3 Government intervention - questions
  13. 1.3 Government intervention - simulations and activities
  14. 1.4 Market failure
  15. 1.4 Market failure - notes
  16. Section 1.4 Market failure - questions
  17. Section 1.4 Market failure - simulations and activities
  18. 1.5 Theory of the firm
  19. 1.5 Theory of the firm - notes (HL only)
    1. Cost theory
    2. Calculating costs
    3. Short-run
    4. Long-run
    5. Internal economies of scale
    6. External economies of scale
    7. Diseconomies of scale
    8. Long run cost curves
    9. The very long run
    10. Revenues
    11. Revenues - notes
    12. Profit
    13. Profit - notes
    14. Combining revenue and cost curves
    15. Profit maximisation - price taker
    16. Profit maximisation - price setter
    17. Alternative aims of firms
    18. Profit, sales and revenue maximisation
    19. Perfect competition
    20. Perfect competition - notes
    21. Short-run to long-run - profits
    22. Short-run to long-run - losses
    23. Shut down price, break-even price
    24. Efficient allocation of resources
    25. Monopoly and oligopoly
    26. Monopoly and oligopoly - introduction
    27. Growth and power
    28. The model of monopoly
    29. Monopoly - profit maximisation
    30. Monopoly equilibrium
    31. Monopoly v. perfect competition
    32. Economic efficiency in perfect competition
    33. Economic efficiency in perfect competition and monopoly
    34. Efficiency and market structure
    35. Monopolistic competition
    36. Monopolistic competition - notes
    37. Monopolistic competition in the short-run
    38. Monopolistic competition in the long run
    39. Oligopoly
    40. Oligopoly - notes
    41. Advertising and branding
    42. Product innovation
    43. Theories of oligopoly - non-collusive
    44. The kinked demand curve theory
    45. Kinked demand curve - change in cost
    46. Cut-price competition (predatory pricing)
    47. Theories of oligopoly - collusive
    48. Forms of collusion
    49. Price discrimination
    50. Equilibrium of the discriminating monopolist
  20. Section 1.5 Theory of the firm - questions
  21. Section 1.5 Theory of the firm - simulations and activities
  22. Print View

Perfect competition - notes

Assumptions of the model

S:\triplea_resources\DP_topic_packs\economics\student_topic_packs\media_microeconomics\images\equality.jpgPerfect competition is considered as the ideal or the standard against which everything is judged. Perfect competition is characterised as having:

  • Many buyers and sellers. Nobody has power over the market.
  • Perfect knowledge by all parties. Customers are aware of all the products on offer and their prices.
  • Firms can sell as much as they want, but only at the ruling price. Thus sellers have no control over market price. They are price takers, not price makers.
  • All firms produce the same product, and all products are perfect substitutes for each other, i.e. goods produced are homogenous.
  • There is no advertising.
  • There is freedom of entry and exit from the market. Sunk costs are few, if any. Firms can, and will come and go as they wish. There are no barriers to entry such as licenses.
  • Companies in perfect competition in the long-run are both productively and allocatively efficient.

Equilibrium under perfect competition

In perfect competition, the market is the sum of all of the individual firms. The market is modelled by the standard market diagram (demand and supply) and the firm is modelled by the cost model (standard average and marginal cost curves). The firm as a price taker simply 'takes' and charges the market price (P* in Figure 1 below). This price represents their average and marginal revenue curve. Onto this we superimpose the marginal and average cost curves and this gives us the equilibrium of the firm.


Figure 1 Equilibrium of the firm and industry in perfect competition

Firms in equilibrium in perfect competition will make just normal profit. This level of profit is just enough to keep them in the industry and since profits are adequate they have no incentive to leave.


Normal profits

Normal profit is the level of profit that is required for a firm to keep the resources they are using in their current use. In other words it is enough profit to keep them in the industry. Anything in excess of normal profits is called abnormal or supernormal profits.

Any profit above normal profit is a 'bonus' for the firms, as it is more than they need to keep them in the industry. We call this supernormal (or abnormal) profit. However, this supernormal profit will be a signal to other firms and will attract more firms into the industry. If firms are making consistently below normal profits then they will choose to leave the industry.