(a) What is perfect competition? (b) With the aid of diagrams, compare the short run equilibrium positions of a perfect competitor and an imperfect competit...

Answer Details

(a) Perfect competition is a market structure in which there are very many buyers and sellers dealing in a homogeneous (identical) product, with freedom of entry and exit, perfect knowledge, and no single participant able to influence price. Each firm is therefore a price taker.

(b) Short-run equilibrium: perfect competitor versus imperfect competitor

Both firms maximise profit at the output where marginal cost equals marginal revenue (MC = MR), and both may earn abnormal profit, normal profit or a loss in the short run. The differences lie in the demand (average revenue) curve:

• For the perfect competitor, the firm faces a horizontal (perfectly elastic) demand curve at the ruling market price, so \( P = AR = MR \). Equilibrium output is where MC cuts this horizontal line from below.
• For the imperfect competitor (for example a monopolist or monopolistic competitor), the demand curve slopes downward, and marginal revenue lies below average revenue. Here price is read off the AR curve above the MC = MR output, so \( P > MR \).

On the diagrams the perfect competitor's price line is a flat line touched by MC; the imperfect competitor's AR and MR are two separate downward-sloping lines, with equilibrium output below MC = MR and price taken up on the AR curve.

(c) Two features of an imperfect market

• Product differentiation or a single/few sellers, so firms are price makers rather than price takers.
• Barriers to entry and imperfect knowledge among buyers and sellers.