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REQUIREMENTS Perfect competition requires that the following six parameters be fulfilled. In such a market, prices would normally move instantaneously to economic equilibrium. ; Atomicity: An Atomistic Market is one in which there are a large number of small producers and consumers on a given market, each so small that its actions have no significant impact on others. Firms are '' Price Taker s'', meaning that the market sets the price that they must choose. ; Homogeneity:Goods and services are perfect substitutes; that is, there is no product differentiation. (All firms sell an identical product) ; Perfect and complete information: All firms and consumers know the prices set by all firms (see Perfect Information and Complete Information ). ; Equal access: All firms have access to production technologies, and resources are perfectly mobile. ; Free entry: Any firm may enter or exit the market as it wishes (see Barriers To Entry ). ; Individual buyers and sellers act independently: The market is such that there is no scope for groups of buyers and/or sellers to come together with a view to changing the market price (collusion and cartels are not possible under this market structure) Behavioral assumptions of perfect competition are that: #Consumers aim to maximize utility #Producers aim to maximize profits. RESULTS .)]] The model is a Description of one type of market structure, most closely approximating only a few markets, such as agriculture. In real-world markets, any of its assumptions may be violated. For example, firms will never have perfect information about each other. Its usefulness as a scientific construct may be judged by the range of market behavior Explained by it and as a standard for comparison with other market structures. In a perfectly competitive market, there will be Allocative Efficiency and Productive Efficiency .
In contrast to a Monopoly or Oligopoly , it is impossible for a firm in perfect competition to earn Abnormal Profit in the long run, which is to say that a firm cannot make any more money than is necessary to cover its economic costs. If a firm is earning abnormal profit in the short term, this will act as a trigger for other firms to enter the market. They will compete with the first firm, driving the market price down until all firms are earning normal profit, it could be said that abnormal profit is 'competed away'. On the other hand, if firms are making a loss, then some firms will leave the industry, reduce the supply and increase the price. Therefore, all firms can only make Normal Profit in the long run. It is important to note that perfect competition is a sufficient condition for allocative and productive efficiency, but it is not a necessary condition. Laboratory experiments in which participants have significant price setting power and little or no information about their counterparts consistently produce efficient results given the proper trading institutions (Smith, 1987, p. 245). THE SHUTDOWN POINT When a firm is making loss, it will have to decide whether to continue production or not. This decision will, in fact, depend on the different total costs levels and whether the firm is operating in the short run or in the long run. If the firm is in the short run, and is making a loss whereby:
it is advisable for the firm to continue production. If it fails to achieve these conditions, it is advised to close down so that the only costs the firm will have to pay will be the Fixed Costs . Even if the firm stop producing, it will have to continue to meet the level of fixed costs. Since whether the firm produces or not, it will have to pay fixed costs, it is better for it to continue production in an attempt to decrease total costs and increase total revenue, thus making profits. This can be done by:
In the long run, the condition to continue producing requires the price P to be higher than the ATC, i.e. the line representing market price should be above the minimum point of the ATC curve. If P is equal to ATC, the firm is indifferent between shutting down and continuing to produce. This case is different from the short run shut down case because in long run there's no longer a fixed cost (everything is variable). EXAMPLES Some Agricultural markets, with numerous suppliers and almost perfectly substitutable products have been suggested as approximations for the perfect-competition model. The extent of its applicability may be dependent on the market in question. Agricultural policies in many countries undermine the requirements for complete Pareto efficiency to apply. Perhaps the closest thing to a perfectly competitive market would be a large auction of identical goods with all potential buyers and sellers present. By design, a Stock Exchange resembles this, not as a complete description (for no markets may satisfy all requirements of the model) but as an approximation. The flaw in considering the stock exchange as an example of Perfect Competition is the fact that large institutional investors (e.g. investment banks) may solely influence the market price. This, of course, violates the condition that "no one seller can influence market price". eBay auctions can be often be seen as perfectly competitive. There are very low Barriers To Entry (anyone can sell a product, provided they have some knowledge of Computers and the Internet ), many sellers of common products and many potential buyers. In the eBay market competitive advertising does not occur, because the products are homogeneous and this would be redundant. However, generic advertising (advertising which benefits the industry as a whole and does not mention any brand names) may occur. |
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