Sample Paper

Words 2,100

Question A: The problem with perfect competition is that supernormal profit is not achievable in the long-run. Discuss. Students need to lay out the assumptions of a perfectly competitive market, highlighting the absence of barriers to entry.

Perfectly competitive markets have four basic assumptions (McConnell and Brue, 2008):

Large number of sellers: under perfect competition there are many sellers in a market. They offer their products in large international or domestic markets. For example, farm commodities, foreign exchange and stock markets.

Standardised goods: all the goods on offer are homogenised. No differentiation like brand name or other non price competition takes place as the price of all the products is set and the buyer is indifferent to the seller because the price is same for all.

Price takers: the market determines price of the product in this market. Because the contribution of individual seller is so small that his or her change in price does not influence overall market price. Therefore all sellers are price takers as they cannot change the market price but adjust their price to it.

Absence of entry and exit barriers: in perfectly competitive markets there are no barriers to entry or exit. Therefore anyone can enter or exit a market without any problem.

When one analyses the fourth assumption it becomes clear that absence of entry barriers can lead to a situation where supernormal profits cannot be enjoyed. According to Bain (1956, p. 52):

The advantages of established sellers in an industry over potential entrant sellers, these advantages being reflected in the extent to which established sellers can persistently raise their prices above a competitive level without attracting new firms to enter the industry.

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