18. Perfect Competition (3)
1. Complete the following table
Type of Efficiency
Definition
Condition
Productive
P (AR)=MC
Abnormal profits give scope for reinvestment and funding for research,
development and innovation.
2. Perfect Competition and Economic Efficiency
2.1 Produce perfect competition diagrams for the short and long-run (use separate diagrams, drawn overleaf).
2.2 Using the table in Question 1, decide which types of efficiency are achieved under perfect competition in the
short and long run.
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3. Multiple Choice
Question
3.1
3.2
3.3
Possible answers
Which of the following markets best resembles the
model of perfect competition?
A firm in short-run equilibrium under the model of
perfect competition will
Supernormal profits in the model for perfect
competition are only possible in the short-run
because in the long-run
A
Motorcycle manufacturing
B
Foreign exchange market
C
Telephone services
A
Make only normal profit
B
Cover only their fixed costs
C
Be productively inefficient
A
Regulators will reduce prices
B
New firms enter the market
C
Firms engage in advertising
Ans
4. Firms facing difficulty
You have just started work at a firm in a perfectly competitive market. The manager is a little distressed, as the firm
is currently making a loss. He shows you the firms cost and revenue diagram:
Price
MC
4.1 Highlight the area of loss on the diagram.
AC
AVC
E
D=AR=MR
4.2 What does the vertical distance between AC and
AVC represent? ____________________________
________________________________________
4.3 The manager asks you if you think the firm ought
to shut down- how do you respond?
P1
________________________________________
Q1
Output
________________________________________
________________________________________
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18. ANSWERS: Perfect Competition (3)
1.
Type of Efficiency
Definition
Where a firm produces at the lowest
point on its average cost curve and
thus minimises the use of resources
per unit produced.
Occurs when resources cannot be
reallocated to produce a different
combination of goods that will
increase economic welfare.
Abnormal profits give scope for reinvestment and funding for research,
development and innovation.
Productive
Allocative
Dynamic
2.1
Price
Condition
Short-run
MC=AC
P(AR)=MC
AR > AC
Long-run
Price
MC
MC
AC
E
P1
D=AR=MR
E2
P2
Q1
Q2
Output
AC
D1=AR1=MR
Output
2.2
Type of Efficiency
Short-run
Long-run
3.1
3.2
3.3
Productive
X
√
Allocative
Dynamic
√
√
X
√
B
C
B
4.1
AC
AVC
LOSS
P1
4.2 Average fixed cost (AFC=TFC/Q)
MC
Price
D=AR=MR
E
Output
Q1
4.3 You ought to suggest that the firm continue to
operate at Q1, even at a loss in the short-run. This
is because the firm is currently covering AVC, and
therefore making a contribution towards their
fixed costs. By shutting down immediately, the firm
would still have to pay these fixed costs, and would
incur a greater loss. The firm must also assume
that other firms are in the same position, and if
they begin to drop out of the market, market price
will begin to rise, and the firm may return to
normal profit. The shut-down point for a firm is
when AR=AVC.
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