# Perfect Competition

Business I · Microeconomics · https://tryals.app/learn/business-i/perfect-competition

## The Market Benchmark

**Perfect competition** is the ideal market benchmark driven by four strict rules: many small firms, a **homogeneous product**, **free entry and exit**, and **perfect information**.

Every firm is a **price taker**, meaning it accepts the market price as given. Its demand curve is a **horizontal line**.

To maximise profit $\pi = TR - TC$, the firm sets output where price equals marginal cost:

$$P = MC$$

Total surplus is maximised with zero deadweight loss. This is the **first theorem of welfare economics**: competitive equilibrium is Pareto efficient.

## Supply & Shutdown

A firm's short-run supply is its **marginal cost** curve above minimum **average variable cost**. The **shutdown point** occurs when $P < AVC_{\min}$.

| Condition | Decision |
|---|---|
| $P > AC$ | Produce; positive profit |
| $AVC < P < AC$ | Produce at a loss; covers fixed costs partially |
| $P < AVC$ | Shut down; minimise losses |

> **Pitfall:** Shutting down when profit is merely negative. Between $AVC$ and $AC$, producing is better than closing because revenue covers all variable costs and part of fixed costs.

In long-run equilibrium, free entry drives **economic profit to zero**, so $P = MC = AC_{\min}$.

## Practice questions

5 of this lesson's 14 practice questions, with answers. The full set is in the app.

### 1. In long-run competitive equilibrium, $P = MC = AC_{\min}$.

**Answer:** True

**Why:** $P = MC$ (profit maximisation) and $P = AC_{\min}$ (zero profit from free entry). Both hold simultaneously, the firm produces at its most efficient scale.

Page: https://tryals.app/practice/business-i/perfect-competition/in-long-run-competitive-equilibrium-p-mc-acmin

### 2. A firm has $TR = 10 \times 30 = 300$ and $TC = 250$. **Estimate profit.**

**Answer:** 50 (within ±5)

**Why:** $\pi = TR - TC = 300 - 250 = 50$. In the short run, positive profit is possible; in the long run, entry would erode it.

Page: https://tryals.app/practice/business-i/perfect-competition/a-firm-has-tr-10-30-300-and-tc-250-estimate-profit

### 3. Order the long-run adjustment process in a competitive market.

**Answer:**

1. Demand increases, pushing price above AC
2. Existing firms earn positive economic profit
3. New firms enter the market
4. Market supply increases, price falls
5. Price returns to $AC_{\min}$, profit returns to zero

**Why:** Shock, profit, entry, supply increase, zero profit restored, the self-correcting mechanism of competition.

Page: https://tryals.app/practice/business-i/perfect-competition/order-the-long-run-adjustment-process-in-a-competitive-market

### 4. Match each competitive concept to its meaning.

**Answer:**

- $P = MC$ → Profit-maximising output rule
- $P = AC_{\min}$ → Long-run zero-profit condition
- Shutdown point → $P < AVC_{\min}$: better to produce nothing
- Free entry/exit → Drives economic profit to zero in the long run

**Why:** The four pillars of competitive equilibrium, price equals marginal cost, zero profit, shutdown condition, and entry/exit dynamics.

Page: https://tryals.app/practice/business-i/perfect-competition/match-each-competitive-concept-to-its-meaning

### 5. In long-run competitive equilibrium firms make zero economic profit. Why is that not a description of firms barely surviving?

A. Because accounting rules allow profits to be reported despite zero economic profit
B. Because the zero-profit condition holds only on average across the industry
C. Because economic profit already subtracts opportunity cost
D. Because firms in competitive markets are subsidised to remain viable

**Answer:** C. Because economic profit already subtracts opportunity cost

**Why:** The owner's forgone salary and the capital's forgone return are already deducted, so zero economic profit means a normal return is being earned, the accountant would report a healthy figure. Free entry is what drives it there, and it is why 'competitive industries make no money' is a misreading of the units.

Page: https://tryals.app/practice/business-i/perfect-competition/in-long-run-competitive-equilibrium-firms-make-zero-economic-profit