Explain what is meant by the term "perfect competition"

Perfect competiton in a market is defined as being a set of conditions where markets have little to no entry or exit barriers. These may be natural or synthetic. An example of a natural barrier to entry is high start up costs whereas incumbant firms in the industry may set up a synthetic barrier which could be relating to high administrative costs and high amounts of admin time through regulation. The effect of the lack of these barriers is demonstrated in the diagram below:

[Diagram showing a horizontal AR=MR=D curve with an AC curve where the lowest point intersects the demand curve, and an MC curve intersecting the AC curve at its lowest point]

Here, we can see at quantity Q and price P that the costs and revenue of the firm in the market are the same. This is due to the fact that large amounts of competition leads to normal profit (where firms 'break even'). If a firm was to increase its prices above P, there would be no consumers for the firm and if it were to decrease its prices below this level, all other firms would follow suit soon after. Therefore, in the short run there may be a level of supernormal profit in the market but in the long run only normal profits are sustainable.

Answered by Lucas E. Economics tutor

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