Perfect Competition


5 Characteristics

1. Many buyers and sellers

2. Homogenous goods

3. Perfect information

4. No barriers to entry

5. Price takers

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In the short-run, a firm will make supernormal profits because the AC<AR at Q1, where the firm is profit maximising (MC=MR). However, in the long run the supernormal profits will erode, because new firms have entered the market, and the price mechanism has signalled to other firmss where they should allocate their resources instead. As a result, this increase in market supply from S1 to S2, forces the market equilibrium price to fall from P1 to P2, and subsequently shifts the D=AR curve downward. This means now the firm is not making any economic profit, because AC now equals to AR.

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Theory Criticisms

Unrealistic - there are practically zero markets that perfect comp. is the market, as no market fulfils the five characteristics

Information is not perfect - even though homenous markets e.g forex arec lose, all information is not available

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