Question

1) What are the requirements for perfect competition?

2) Define the shutdown point. Explain why the firm shuts down in the short run if the price falls below this point.

3) In the long run, perfectly competitive firms cannot make an economic profit. Why?

4) Describe how economic losses are eliminated in a perfectly competitive industry.

Answer 1

1) Perfect competition is a market situation in which there are many firms which sell identical products to a large number of buyers. The requirements for perfect competition are mentioned below:

a) Large number of buyers & sellers: There are many small buyers & sellers in the market. Both buyers & sellers are price takers, no individual buyer & seller is large enough to dominate the market & are unable to exercise any significant influence over price. Each buys or sells a small portion of the total quantity in the market.

b) No barriers to entry: Sellers can enter & exit the perfectly competitive market freely & easily.

c) Homogeneous product: There is no product differentiation. Buyers cannot differentiate between the products offered by different sellers. The products offered by sellers are identical.

d) Profit maximization: The profit of the firm is maximized at the point where marginal costs equals the marginal revenue.

e) Complete information: All the buyers & sellers are assumed to have perfect information about the price & quality of the products.

f) No transportation cost: There are no transportation costs incurred in carrying goods from one market to another.