Question

Q1. While defining the concept of market efficiency, briefly describe the theoretical basis of measuring efficiency under a perfectly competitive market. Q2. What are the assumptions made in answering Q1? What happens if those assumptions are not valid?

Answer 1

Efficient market theory assumes that share price of firm fully denote its all information .

In perfectly competitive market entry barriers are low and relatively smaller firms in large numbers are foreseen.

As results the profit margins are thin and price monopoly is impossible which results stock prices to remain stagnant .

Now with efficient market theory we assumed that stock prices denote all information which is at time invalid because even if profit margins are thin and stock prices are low it doesn't completely reflect the performance and future growth prospects .

Sone firms may have strong management structures and well defined ethical standards and strong product pipeline . In short run they make losses but in long run good economic profit is foreseen .

Hence market efficiency is ambigous to predict in perfect competition market.