Compare and contrast the way in which an individual firm and the industry determine there short run and long run outputs under perfect competition.
The market system determines what, how and for whom goods and services are produced. The consumer determines what to produce. An increase in consumer demand will lead to a rise in price and producers will respond to higher price by raising production- to make more profits. Competition between producers determines how to produce- if they do not want to produce as cheaply as possible they will go out of business. For whom to produce is decided by prices in factor markets. Some people have high incomes because there skills are scarce and they can afford more resources.
Perfect competition (sometimes known as pure competition) is a theoretical type of market structure. It is primarily used as a benchmark in comparison with other market structures.
The structure of a market determines the behaviour and performance of firms that sell in the market. A real life example could be that fishermen and farmers often operate in perfectly competitive markets.
Main theories
Assumptions of Perfect Competition
• There are many firms each selling an identical product
• There are many buyers
• There are no restrictions on entry to the industry
• Firms in the industry have no advantage over potential new entrants
• Firms and buyers have complete information about the market
• Price taker
Since in perfect competition there are many firms selling a homogenous product no single firm can influence the market to a greater extent than any other, hence all firms must accept the market price for their product. They are price takers.
The Short Run and the Long Run
The short run under perfect competition is the period during which there is too little time for new firms to enter the industry.
• In the short run the number of firms are fixed. Firms could be making large or small profits, breaking even or making a loss.
The long run under perfect competition is the period of time which is long enough for new firms to enter the industry.
• In the long run the level of profit will affect the entry or exit of firms.
• Normal profit is the level of profit just sufficient to persuade firms to stay in the industry, but not high enough to attract new firms. This level of normal profit will vary from one industry to another.
• Supernormal profit is any profit above normal profit. If economic profits are being made new firms will be attracted into the industry in the long run. This will have the effect of increasing supply and reducing price and profit for those firms already in the industry. Economic profits will be completed away.
Output - the firm is making a profit over the output range 4 to 12 (TR [next page]