Question

List the five assumptions of perfect competition and tell how they combine to insure that in the long-run, a firm in a perfectly competitive industry makes zero profit and is a price taker.

Answer 1

Answer

Assumption of Perfect competition

1, Large number of buyers and sellers.

2, The product sold in the market will be identical.

3, Freedom of entry and exit.

4, Absence of government intervention.

5, Perfect knowledge of market condition.

In the long run firm make zero profit because ◆there is large numbers of buyers so if a firm try to raise the price for gaining profit then the customer will go to another seller.

◆the product produced in this market is homogeneous which means same colour,smell,size etc so the buyer can buy from any seller.

◆In the short run firms may earn profit, by seeing this new firms enter into the market because firms free to enter and exit this leads to increase in the supply of goods and finally the profit become zero.

◆There is no government intervention to set price floor.

◆Both the seller and buyer have knowledge about the market so the seller can't charge more price because buyers also know the price level existing in the market.

The buyers and sellers are price takers. In the long run the price should be greater than or equal to minimum of LAC in the long run. If price is equal to LAC then the firm will be in a no profit no loss situation. So total revenue equals total cost.

LMC Price LAC P D= AR = MR Quantity