Question

Assume that the market for MBA education is perfectly competitive, and business schools are the representative firms in the industry. Over the last four decades there has been a four-fold increase in the demand for MBAs. Top-quality finance professors are a scarce input, and salaries for these faculty have increased dramatically over the same period. Use this information to demonstrate the long run competitive equilibrium for a firm in the industry as well as the industry as a whole. What happened to the long run equilibrium price of an MBA education over the period?

Answer 1

A perfect market where the sellers of a product or service are free to compete fairly, and sellers and buyers have complete information: The internet has a big part to play in the creation of a perfect market. Compare. imperfect market.

Perfect competition is a market structure where many firms offer a homogeneous product. Because there is freedom of entry and exit and perfect information, firms will make normal profits and prices will be kept low by competitive pressures.

Features of perfect competition

1. Many firms.
2. Freedom of entry and exit; this will require low sunk costs.
3. All firms produce an identical or homogeneous product.
4. All firms are price takers, therefore the firm’s demand curve is perfectly elastic.
5. There is perfect information and knowledge.

Diagram for perfect competition

• The industry price is determined by the interaction of Supply and Demand, leading to a price of Pe.
• The individual firm will maximise output where MR = MC at Q1
• In the long run firms will make normal profits.

Changes in long run equilibrium

1. The effect of an increase in demand for the industry.

If there is an increase in demand there will be an increase in price Therefore the demand curve and hence AR will shift upwards. This will cause firms to make supernormal profits.

This will attract new firms into the market causing price to fall back to the equilibrium of Pe

2. An increase in firms costs

• The AC curve will increase therefore AR< AC
• Firms will now start making a loss and therefore firms will go out of business. This will cause supply to fall causing prices to increase.

Efficiency of perfect competition

• Firms will be allocatively efficient P=MC
• Firms will be productively efficient. Lowest point on AC curve.
• Firms have to remain efficient otherwise they will go out of business. (X-efficiency)
• Firms are unlikely to be dynamically efficient because they have no profits to invest in research and development.
• If there are high fixed costs, firms will not benefit from efficiencies of scale.