State the assumptions of perfect competition. How does a perfectly competitive industry work in the short run and the long run? What makes perfect competition efficient?

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State the assumptions of perfect competition. How does a perfectly competitive industry work in the short run and the long run? What makes perfect competition efficient?

Assumptions behind a Perfectly Competitive Market

In a perfectly competitive market it is assumes that there is a large number of small firms that all produce a homogeneous product. Firms in this market are all price-takers, where they use the selling price that it set by the price equilibrium. A perfectly competitive market also has no barriers to entry or exit; there is also perfect knowledge within the market.

A perfectly competitive market must contain four characteristics in order to be perfectly competitive. These four are better described as:

  • There must be many buyers and sellers in the market however none of these should be able to influence the price. A perfectly competitive market usually has a small number of firms that supply to a small number of buyers. The buyers and sellers in this market are also price takers set by the price equilibrium.
  • All firms in a perfect market should have an identical output, where all the firms produce a homogeneous product (where one good is as good as another) and these goods should be perfect substitutes for one another, in order for the consumers to view the products as identical as each other.
  • A perfect competition is assumed to have no barriers to the entry and exit of firms in the industry where the market should freely allow competition from new suppliers. According to this assumption firms should be able to stop production of products and leave market at its own will without being challenged to do so.
  • The final assumption is that the consumers should have perfect information about the prices and sellers in the market. Therefore as a result of this if a firm charges a higher price than the market equilibrium price there demand will fall to zero as the buyers will be able to choose from any of the other firms in the market. The firms in the industry including existing established firms and new entrants are to have no advantage over one another in terms of technology etc.
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In order to find out how a firm works in the short run and long run in a perfectly competitive industry we have to look at certain factors, such as the profit maximising output of a firm, the profit and losses in the short term, the short run supply curve of a firm and the long run adjustments. By looking at these factors we can determine the industries price, output and economic profits.

Firstly we will start by looking at the profits and losses in the short run for a firm. In the short run the equilibrium market price ...

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Here's what a star student thought of this essay

This essay is structured well, following the subheadings clearly. I liked how the introduction summarises a perfectly competitive market concisely. The style is strong, and allows for a convincing argument. Although a bibliography is often not required, it was nice to see a recognition of where information was collected from. Spelling, punctuation and grammar are strong throughout!

The analysis in this essay is strong. I liked how the characteristics of a perfectly competitive market are clearly laid out and well explained. If I were doing this essay, I would've added a comment saying that in practice no market is perfectly competitive. It just shows extra evaluative skills and understanding that the concept is a model. When talking about market structures, I would always define what marginal cost, average cost, etc are. It's as simple as saying "marginal cost is the extra cost occurred by producing another unit of output" but it ensures the understanding is clear. I would also add that when talking about normal profit in economics, it includes the cost of the entrepreneur to remain in the market. This is not to be confused with profits in day to day discussion which is revenue minus costs. Where average revenue is greater than average costs, this is abnormal profit. The use of the graphs is particularly strong, and the diagrammatical analysis allows for high marks. If I were answering this essay, I would progress where the essay ends to say that a perfectly competitive market is allocatively and productively efficient. A short definition of both and an explanation would suffice.

This essay engages superbly with the question, showing a good progression through understanding and knowledge to analysis. However, the essay neglects the efficiency side of the question, and doesn't discuss why a perfectly competitive market is efficient. I would note that often the last question will hold the most marks, so it's crucial you do not lose focus!