1. Perfect Competition
A2 Economics

2. Aims and Objectives Aim: Understand perfectly competitive markets
Explain the long run equilibrium of perfectly competitive firms.
Analyse the process of perfectly competitive firms making losses.
Evaluate the strategies of persistently loss making firms.

3. Quantity Demanded and Supplied
Starter
Draw a firm in perfect competition making supernormal profit.
Quantity Demanded and Supplied
Revenue & Cost of X
D=AR=MR=P 10
£80
£60 MC
ATC

4. Quantity Demanded and Supplied
Draw the diagram to show Supernormal profit being eroded away and explain.
Price of X
Quantity Demanded and Supplied D
£80 S
Revenue & Cost
D=AR=MR=P 10
The Firm
The Market MC S1
£60
D=AR=MR=P1 8
ATC

5. Long Run Equilibrium: Normal Profit
The Firm
Revenue & Cost MC
ATC
D=AR=MR=P P Q
Quantity Demanded and Supplied
The firm is in equilibrium in the long run, making normal profits where ATC = AR.
Equilibrium output at MC=MR is also where ATC is at its lowest point (productive efficiency).

6. Long Run Equilibrium: Normal Profit
The Firm
Revenue & Cost MC
ATC
D=AR=MR=P P Q
Quantity Demanded and Supplied
This point is also allocatively efficient – best allocation of resources to meet demand.
Firms in perfect comp. are likely to be statically efficient – both allocative and productive efficiency.

7. Dynamic Efficiency Definition:
Efficiency over time – new products, techniques and processes which increase economic growth.
Essential for building supernormal profits.
However, firms in perfect competition are unlikely to be dynamically efficient as supernormal profits cannot be maintained due to free barriers to entry/perfect knowledge.

8. An Example of Perfect Competition
An Example of Perfect Competition? The Internet Economy: Towards A Better Future
Is the internet economy an example of perfect competition?
How many of the assumptions apply to this industry?

9. Quantity Demanded and Supplied
Firms Making Losses
The Market
The Firm
Price of X
Revenue & Cost S MC
ATC S1
£82
£80
D=AR=MR=P1
£80
£60
D=AR=MR=P
£60 D 8 10
Quantity Demanded and Supplied
At market price of £60 the firm is making losses as at output of 8 units , the ATC is £82 whereas the AR is only £60, therefore £22 losses are being made per unit.

10. Quantity Demanded and Supplied
Firms Making Losses
The Market
The Firm
Price of X
Revenue & Cost S1 MC
ATC S
£82
£80
D=AR=MR=P1
£80
£60
D=AR=MR=P
£60 D 8 10
Quantity Demanded and Supplied
Firm producing at MC=MR- meaning it is making the smallest loss possible.
If firms are making losses some will leave the industry (S – S1).

11. Quantity Demanded and Supplied
Firms Making Losses
The Market
The Firm
Price of X
Revenue & Cost S1 MC
ATC S
£82
£80
D=AR=MR=P1
£80
£60
D=AR=MR=P
£60 D 8 10
Quantity Demanded and Supplied
This will lead to higher price of £80.
Here the firm is making normal profit as ATC=AR (10 units)
The firms market share has increased as firms have left the industry.

12. SPEED DATING

13. Firms Entering and Leaving The Industry
The Firm
ATC
Revenue & Cost MC
TFC
£60
AVC
£50
D=AR=MR=P
£40
100
Quantity Demanded and Supplied
Firm producing at MR=MC.
TR = £5000, TC = £6000, Firm is making losses of £1000 per week!

14. Firms Entering and Leaving The Industry
Does the firm shut down immediately? Or close down slowly?
Depends on relationship between AVC and P.
AVC = £4000, ATC = £6000, TFC = £2000.
Firm faces TFC of £2000 which must be paid whether the firm produces or not.
At present running the firm = £1000 Loss
Running firm paying £1000 towards TFC

15. Firms Entering and Leaving The Industry
Shutting down immediately would result in shareholders paying TFC immediately - £2000.
Therefore if P is above AVC it pays the firm to continue production to offset some part of its fixed costs and close down slowly.
If P falls below AVC there is no point in carrying on and the firm should shut down immediately.

16. Worksheet Explain what level of output the firm will produce and why.
What is the firms’ level of losses at this output level?
You have been called in to advise the managing director as to whether the firm should close immediately. Write a brief to explain the costs/benefits of the firm’s options.