Michelle, Olivia, Margaret and Peter are arguing. They all disagree on which market structure is the...

Michelle, Olivia, Margaret and Peter are arguing. They all disagree on which market structure is the best for firms.

Michelle believe monopolistic competition is the best for firms. Olivia believes oligopoly is the best for firms. Margaret believe monopoly is best for firms. And, Peter believes perfect competition is the nest for firms.

Who do you agree with ? Provide your reasoning.

Expert Solution

The features of perfect competition are:

(a) Large Number of Sellers and Buyers: The number of buyers and sellers are large. No buyer or seller can influence the price. The producers are price takers.

(b) Products are identical. The products are homogeneous.

(c) Perfect information. The buyers have perfect information about the products being sold and prices charged.

(d) Perfect mobility of resources like labor

Perfect competition is the best because the welfare to the society is maximized.

In the long run, a competitive firm is in equilibrium when MR=MC=AC. It will produce that output where LMC=LAC. MR= P in perfect competition.

Long term equilibrium of the perfectly competitive firm promotes allocative and productive efficiency. Allocative efficiency because P=MC. Price is the willingness to pay by a consumer, which is the social benefit. MC is the cost to the producer, which is the social cost of producing the good. Allocative efficiency occurs when social benefit equals social cost. Allocative efficiency means that resources are used most efficiently in an economy.

Productive efficiency occurs in perfect competition, because P=minimum ATC. This means the goods are produced at the lowest cost. When a firm is producing at the lowest minimum ATC then the firm is earning normal profits. If P> minimum ATC, then firm is making economic profit and other firms will enter the industry. If P< minimum ATC, then the firm is incurring a loss in the long run. Firms will exit the industry.

In monopoly, oligopoly and monopolistic competition, there is deadweight loss because P > MC. The output level is lower than the output produced in perfect competition and the price is also higher than in perfect competition.

(e) Entry and exit from the industry happens freely.

Rahul Sunny answered 2 years ago

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