(a) Why would a producer (i) enter a competitive market? (ii) leave a competitive market? (b) In what two ways do consumers benefit from perfect competition...

Answer Details

(a)(i) Why a producer enters a competitive market. A producer enters when existing firms are earning supernormal (abnormal) profit, that is, when price (average revenue) exceeds average total cost. Because there is freedom of entry in perfect competition and firms have perfect knowledge, the prospect of these profits attracts new firms into the industry.

(a)(ii) Why a producer leaves a competitive market. A producer leaves when it is making losses, that is, when price falls below average total cost (and, in the short run, below average variable cost so that it cannot even cover its variable costs). Freedom of exit allows unprofitable firms to leave until the remaining firms earn only normal profit.

(b) Two ways consumers benefit from perfect competition.

• Lower prices. Intense competition and free entry drive price down to the level of minimum average cost in the long run, so consumers pay the lowest sustainable price.
• Efficient allocation of resources. Production takes place at the lowest cost and price equals marginal cost, so consumers get the goods they want without waste; there is also no wasteful spending on advertising since the product is homogeneous.

(c) Two conditions for profit maximisation of a perfectly competitive firm.

1. Marginal cost equals marginal revenue: \( MC = MR \).
2. The marginal cost curve cuts the marginal revenue curve from below (\( MC \) is rising at that output), which ensures it is a maximum and not a minimum.

Examination reminder: \( MC = MR \) alone is not enough; the second-order condition that \( MC \) is rising is what confirms profit is maximised.