Question

Define and explain the tenets of the perfectly competitive economic model. Explain, and show using diagrams and labels, why economists argue that competition between producers in markets to supply goods and services, and competition between consumers in markets to buy goods and services, with some conditions applying, will allocate scarce resources efficiently in the economy. Under what conditions, and why, do markets fail. Give examples of market failure, and why these occur, where markets do not provide the amount of goods and services that people would prefer, and which would make people as well off as they could be.

Answer 1

Perfect competition is a market structure characterised by complete absence of rivalry among individual firms.

The tentets of perfectly competitive markets are-

1. Large number of buyers and sellers are present in the market.

2.The products are homogeneous which means there are same types of products available .

3.free entry and exit of firms when ever they want without any conditions.

4.perfect knowledge about the market conditions to both the buyers and sellers.

The fig(i) depicts the market equilibrium with the demand and supply curves where the buyers and sellers interacts with each other. Now if the the supply of goods increases then the supply curve shifts rightwards and the price decreses given the demand in the market thus this effects the firms profit condition where in perfect competition price is equal to average reveneu and marginal reveneu similarly those revenue will also decrease and the profit margin is reduced than the previous case. Now similarly if the consumer demand for goods increases then the demand curve shifts to the right and given the original supply curve the price increases in fig(i) with this effect the firms behaviour also changes in fig(ii) and the marginal revenue increases thus the profit margin increases.

Now if the increase in supply curve is so much due to increse in the entry of new firms then the price falls significantly and when the price falls below the average cost and average variable cost of the firm in fig(ii) then the market fails to operate and the firms get closed this point is also known as the shut down point of the firm .

Any situation that leads to the economic loss of value is regarded as market failure. The monopoly type of market is an example of such failure. Where the sellers enjoys some rights and the buyer is forced to buy the goods at a comperatively higer price.