Step 1: Read the following scenario. Imagine a market where there is perfect com

Question

Step 1: Read the following scenario. Imagine a market where there is perfect competition between two or more companies, such as a fish market where vendors offer the same products at the same price or online ticket auctions like StubHub. In this market there are four key elements to perfect competition: a large number of buyers and sellers no barriers to entry or exit perfect mobility for customers choosing products homogenous products

Step 2: Use the scenario to answer the following questions. In a one-page (250-word) document, answer the following questions using the information provided in the scenario in Step 1: Explain how output, price, and profit are determined in your perfectly competitive market in the long run. How does that lead to efficiency? How could changes in technology affect the market? How could an increase in demand affect the market? What are the effects of new businesses entering the market? What are the effects of businesses leaving the market?

Explanation / Answer

Competition involves one firm trying to gain market share from another, and as a result competition pervades the economy. In perfect competition, both buyers and sellers are price takers. Supply is a schedule of quantities of goods that will be offered to the market at various prices. Since the number of suppliers are large, it means that they do not have the ability to collude. A perfectly competitive firm’s demand schedule is perfectly elastic though the demand curve for the market is downward sloping. This means that firms will increase their output in response to an increase in demand.

Since profit is the difference between total revenue and total cost, profit in response to change in output is determined by marginal cost and marginal revenue. Since the market price is given for a competitive firm, marginal revenue is its price (MR = P). To maximize profits, a frim should produce where marginal costs equal marginal revenue. It is unlikely that economic profits will be unreasonably high in the long run because of the relative ease with which new firms can enter a competitive market.

When the profits are abnormal, existing firms will increase the output, and other firms will enter the market. This shifts the market supply curve to the right. As a result new firms try to enter the market drawn by the abnormal profits, shifts the supply curve back to the left, where economic profits are zero. This is the long-run equilibrium price in the market, because there are no more above normal profits. If firms in the industry are incurring losses, than some will go out of business.

In a changing scenario of technology advancement, the market price falls, and each firm decreases the quantity it produces. Economic losses induce some firms to exit in the long-run, which decreases the market supply and the price starts to rise. A new long-run equilibrium occurs when the price has risen to equal minimum average total cost. Firms make zero economic profits, and firms no longer exit the market.

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