Perfectly Competitive Market | Economics for JAMB PDF Download

Assumptions and Characteristics

Large Number of Buyers and Sellers: In a perfectly competitive market, there are numerous buyers and sellers, none of which can individually influence the market price. Each participant is a price taker, meaning they must accept the prevailing market price.

• Homogeneous Products: The goods or services offered by firms in a perfectly competitive market are identical or very similar in nature. There is no differentiation based on branding, quality, or features.
• Perfect Information: All buyers and sellers have access to complete and accurate information about market conditions, including prices, quantities, and product attributes. There are no information asymmetries.
• Free Entry and Exit: Firms can freely enter or exit the market without facing significant barriers or restrictions. There are no artificial barriers to entry, such as government regulations or high start-up costs.
• Perfect Factor Mobility: The productive resources, such as labor and capital, can move freely between different firms or industries without incurring any costs. There are no restrictions on the mobility of resources.

Short-Run and Long-Run Equilibrium of a Perfect Competitor

1. Short-Run Equilibrium:
In the short run, a perfectly competitive firm can earn profits, incur losses, or break even. The equilibrium condition for a firm in the short run is where marginal cost (MC) equals marginal revenue (MR) and MC cuts the marginal cost curve from below.

• Profit Maximization: If the market price (P) is above the average total cost (ATC) at the profit-maximizing quantity, the firm earns positive economic profits. In this case, the firm will continue to produce in the short run.
• Loss Minimization: If the market price is below the ATC but above the average variable cost (AVC), the firm incurs losses but may continue producing to minimize losses. It is better to produce at a loss than to shut down and incur fixed costs.
• Shutdown Point: If the market price falls below the AVC, the firm will shut down and produce zero output in the short run. It minimizes losses equal to the fixed costs.

2. Long-Run Equilibrium:
In the long run, firms in a perfectly competitive market will adjust their production levels and resources to achieve a state of long-run equilibrium. This occurs when all firms in the industry earn zero economic profits.

• Entry and Exit of Firms: If firms in the industry are earning economic profits, new firms will be attracted to enter the market, increasing supply and driving down prices. Conversely, if firms are incurring losses, some firms will exit the market, reducing supply and increasing prices.
• Zero Economic Profits: In the long run, the market price will adjust to the point where each firm earns zero economic profits. At this equilibrium, the price (P) will be equal to the average total cost (ATC), average variable cost (AVC), and marginal cost (MC).
• Allocative and Productive Efficiency: Perfect competition leads to allocative efficiency, where resources are allocated to their most valued uses. It also promotes productive efficiency, as firms produce at the lowest average cost.

In summary, a perfectly competitive market is characterized by a large number of buyers and sellers, homogeneous products, perfect information, free entry and exit, and perfect factor mobility. In the short run, firms can earn profits, incur losses, or break even. In the long run, firms adjust their production levels until zero economic profits are achieved, leading to allocative and productive efficiency.