Theory question 107
Market Structures(a) Why would a producer (i) enter a competitive market? (ii) leave a competitive market?
(b) In what two ways do consumers benefit from perfect competition?
(c) Give the two conditions necessary for profit maximization for a perfectly competitive firm.
Show the model answer
(a)(i) A producer enters when existing firms are earning supernormal (abnormal) profits, since there are no barriers to entry.
(ii) A producer leaves when it makes losses, i.e. price (AR) is below average cost in the long run (or below average variable cost in the short run).
(b) Any two: goods are sold at the lowest possible price (P = minimum AC in the long run); uniform price for all buyers; consumers have perfect knowledge so are not exploited; resources are used efficiently; homogeneous goods of the same quality.
(c) Marginal cost equals marginal revenue (MC = MR = price); and the MC curve cuts MR from below (MC rising at that point).
Profit maximisation needs MC = MR with MC rising.