Question

•What are the main characteristics of a perfectly competitive industry?   [5 marks]

•With aid of diagrams explain and illustrate the long run equilibrium conditions of the perfectly competition firm.                                                                [10 marks]

Answer 1

Characteristics of perfect comptt:

1) large no of buyers and sellers

There are large number of sellers in the mkt that no individual seller can affect market supply i.e if some of the sellers will exit the market ,mkt supply remains unaffected.

similarly if some of the buyers will stop buying the good , mkt demand will not get affected.

2) Homogenous good

Sellers are selling homogenous good i.e goods are exactly same in each and every feature : shape ,size ,color etc

Product differentiation does not exist.

3) Price taker

Firms are price taker i.e they will accept price decided by the market. No seller can change price of good according to his will because large number of sellers are selling homogenous good .If seller will decide higher price than mkt ,buyers will shift to other seller

4) Free entry and exit of firms

under perfect comptt , firms are free to enter and exit the mkt. There are no barriers or restrictions either natural or artificial .

If firms are making abnormal profit ,new firms will enter and if firms are facing losses ,existing firm can exit the mkt.

Thus,firms are able to earn normal profit under long run in perfect comptt

b) long run equilibrium condition

For eq under perfect comptt:

MR = MC

since ,MR = AR = P

so , P = MC

Firms under perfect comptt in long run are able to earn only normal profit and operates at minimum AVC ( no excess capacity)

In the following diagram, left side shows demand and supply of mkt which decides OP as equilibrium price.

Right hand side shows firm of perfect comptt.

OP will be accepted as price by firm.

P = AR = MR under perfect comptt

For eq :

MR = MC

so, Equilibrium condition will be

P= MR = MC

since ,firm operates at min of long run AC which is min of SAC also and

LMC = LAC

SMC = SAC

so, LMC = LAC = SMC = SAC =P =MR

will be equilibrium condition .

equilibrium price = OP

Equibrium qty = OQ