Perfect Competition (Short-Run Equilibrium)

Market structure is highly important in economics. Different market structures provide diverse situations in terms of assumptions behind the structure and their implications upon firms and households.

Perfect competition is considered to be the opposite to a monopolistic market structure. Perfect competition is also considered to be highly competitive and thus highly theoretical. The assumptions behind this type of market structure are:

• Infinite number of both buyers and sellers
• 'Homogeneous' products. This just means that all the products are the same. This assumption stems from the matter that there is no asymmetrical knowledge, all stakeholders in the market are subjected to all the information, and thus, no innovation can occur due to this perfect knowledge. Therefore, all products are perfect substitutes for each other. 
• Freedom of entry and exit barriers in the long run - lack of patents, sunk costs and high start up costs, bureaucracy etc. These markets are said to be perfectly contestable  as cost advantages are said to create a barrier to entry (such as a firm benefiting from economies of scale) and therefore it assumes that all firms cost structures are the same. 
• Firms are 'price takers' whereby firms have to succumb to the price 'ruling' in the market. 
• Firms have equal access to fully mobile factors of production.

Obviously, such assumptions mean that this structure is theoretical. However, there are some close approximations. Such as Forex and fruit sellers at a local market. 

Perfect Competition and the short run equilibrium

*Note* This image is from tutor2u

As the diagram depicts, the left hand side displays exactly what is happening holistically in the industry alongside the effect upon the firm. 

The firm accepts the price as set by the forces of demand and supply in the industry (hence, price takers) and as a result both the average and marginal revenue curves converge as set by the industry. In the short run, it is possible that the firm can achieve 'super-normal' profits, where MC = MR, which is illustrated by the shaded blue box. (We are assuming here that these firms are profit maximisers and will produce at output Q1, P1). The supernormal profit is achieved as the Average Revenue is > than the Average Cost. 

At the point Q1, the firm is productively inefficient and allocatively inefficient in the short run. 

What happens in the long run will be covered next time. 

Note: These notes are formulated with credit to the website Tutor2u, AQA Economics Textbook by Lawrence and Stoddard, and Business Microeconomics by Nutter.