Question

What are the assumptions of perfect competition and what do they imply about the firms’s profits in the short and long run?

Answer 1

Answer : 1) Assumptions of perfect competition are follows :

I) There exists many buyers and sellers in the market.

II) All sellers are price taker.

III) All sellers sell homogeneous products.

IV) There exists free entry and exit barrier in the market.

V) Buyers have perfect information about the market.

2) In short run perfectly competitive firms earn profit. But due to existing free entry barrier in long run many firms enter into the market. As all sellers sell homogeneous products and many firms enter into the market hence the market supply increase. This decrease the price level continuously until it reaches to average total cost. As a result, in long run perfectly competitive firms earn zero economic profit. So, the assumptions of perfect competition imply that in short run firms earn positive economic profit but in long run firms earn zero economic profit.