Answer to Question #75592 in Economics for njabulo magagula

Question

4.2 Explain using properly labelled diagrams, why a perfectly competitive firm will earn only normal profit in the long-run. (16)
4.3 Explain SEVEN (7) conditions necessary for a perfectly competitive market to exist.

Answer 1

4.2 Firms can only make normal profits in the long run, although they can make abnormal (super-normal) profits in the short run. It is because in the long run the number of firms is such that P = MR = MC = LATC and LATC is a its minimum.
4.3 Perfectly competitive markets exhibit the following characteristics:
1) There is perfect knowledge, with no information failure or time lags in the flow of information. Knowledge is freely available to all participants, which means that risk-taking is minimal and the role of the entrepreneur is limited.
2) Given that producers and consumers have perfect knowledge, it is assumed that they make rational decisions to maximise their self interest - consumers look to maximise their utility, and producers look to maximise their profits.
3) There are no barriers to entry into or exit out of the market.
4) Firms produce homogeneous, identical, units of output that are not branded.
5) Each unit of input, such as units of labour, are also homogeneous.
6) No single firm can influence the market price, or market conditions. The single firm is said to be a price taker, taking its price from the whole industry. The single firm will not increase its price independently given that it will not sell any goods at all. Neither will the rational producer lower price below the market price given that it can sell all it produces at the market price.
7) There are very many firms in the market - too many to measure. This is a result of having no barreirs to entry.
Source:
https://www.economicsonline.co.uk/Business_economics/Perfect_competition.html