Contents:
- Learning Outcomes
- Definitions
- Perfect Market Structures
Candidates should be able to:
- [ ] Understand how perfect and monopoly operate in the short and the long run
- [ ] Understand how firms achieve economic efficiency
- [ ] Learn how price discrimination works
Definitions
| Productive Efficiency |
When an economy gets the most out of the limited resources available |
| Allocative Efficiency |
When goods and services that are sold to consumers are allocated in a way that benefit both the sellers and the buyers |
| Perfect competition |
A type of market structure that, in the long-run equilibrium, results in allocative and productive efficiency |
| Monopoly |
Sole provider of a good |
| Natural monopoly |
An industry or service that operates most effectively as a monopoly because if there were other suppliers, the average costs would be greater |
| Price discrimination |
The practice of charging different prices for the same product in several markets |
4.1 Perfect Market Structures
4.1.1 Perfect Competition in the Short-Run
Perfect competition is built on 4 assumptions:
- Firms are price takers: The industry is filled with an infinite number of firms, each of which contributes only a negligibly small amount to the total supply. As a result, no firm has the ability to influence the product's pricing.
- New firms have complete freedom to enter and leave the industry: Established businesses cannot prevent new firms from opening for business. However, starting a business takes time. Thus, freedom of entry is applicable only in the long run.
- A Homogeneous product is produced by all firms: Identical good is produced by all firms. Therefore, there is neither branding nor advertising.
- The market is perfectly understood by both producers and consumers: Producers are fully aware of prices, costs, and potential growth. Consumers, who are also infinite in number, have perfect knowledge about the product's price, quality, and accessibility.
These assumptions are followed strictly. Only few industries meet these conditions in the real world. An example would be the market for fresh vegetables. The model can, thus, be used as a benchmark to evaluate the problems in actual industries. Governments may use it to assist them create policies for the industry.