Question

1. Describe the nature of perfect competition. What is a perfectly competitive market and industry? Provide a detailed discussion.

2. Explain what is meant by a price-taking producer and a price-taking consumer. How does this relate to perfect competition?

3. What is meant by free entry and exit? Provide a realistic example.

Answer 1

1.

Nature of the perfect competition is that firms are price takers and they can entry and exit from the market. So, perfectly competitive market is the market where firms or producers come up with their homogeneous products and price is fixed by the market demand and supply, and firms take that price.  It constitutes the perfectly competitive industry where the long run economic profit will zero for all the firms, though, they can earn positive or negative economic profit in the shirt run. At firm level, the demand curve is perfectly elastic in nature and make it to be  horizontal in nature. When firms in the industry get their marginal revenue to be less than the AVC, they exit from the market and it leads to decrease in supply and increase in price at industry level. This increased price level is followed by all the firms and process continues unless they achieve long run equilibrium in the perfectly competitive market. Here, perfectly competitive market and industry are generally used for each other.

2.

Price taking producer means producers do not influence the price or producer does not set the price in the market. It is the huge number of buyers and sellers in the market that leads to the fixation of price. Price taking consumers mean consumers take the price what is fixed in the market. In perfectly competition also, consumers just like producers, take the price as it is prevailing in the market. It relates to the perfect competition in a way that both of these entities do not affect the price and both groups are price takers in the perfect competition.

Though, in other competitions such as monopoly, or monopolistic competition, the customers take price that is fixed by the sellers or firms.

3.

Free entry and exit means there is no barrier in the market. When producers find that they are getting losses in a way that price is less than AVC, then they shutdown and move out. When producers see that other producers are earning positive economic profit, then they enter the market without any significant investments. One realistic example is of fruits and vegetables market. If producers find price to be less than AVC, they stop selling and move out from the market. But, if they find price to be high, they enter the market and start selling again. It is a case of free entry and exit, as there is no barriers.