Economics Quiz 1: Perfect Competition and Market Dynamics

This economics quiz explores the concept of perfect competition, focusing on long-run outcomes. The quiz addresses why perfect competitors cannot earn above-normal profits in the long run, explaining how new firms enter the market, driving profits to zero. It also details the characteristics of long-run equilibrium, emphasizing allocative and productive efficiency, and the absence of barriers to entry. The quiz further examines the theoretical assumptions of perfect competition, contrasting them with real-world market dynamics, and highlighting the limitations of the model. The solutions provided explain how the market adjusts in the long run, leading to normal profits and efficient resource allocation, but also acknowledges the impracticality of perfectly competitive markets in reality due to factors like product differentiation and information asymmetry.

Running head: ECONOMICS QUIZ
ECONOMICS QUIZ
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1ECONOMICS QUIZ
Answer to 1
Existences of a large number of producers and firms in the market characterizes
perfectly competitive market. Under perfect competition, the profit-maximizing level of price
and output is determined by equalizing the marginal cost curve with the horizontal marginal
revenue line. In the short run, under a perfectly competitive market firm can produce positive
profits. This is because there is a comparatively lower number of firms in the short run. In
contrast to this, in the long-run, the profits are distributed among the new entries. This is
because the supernormal profit earned by the producers in the short run draws new producers
to enter the competitive market. Moreover, there is an absence to the entry of new producers
in the market system. Hence, new firms can easily enter the market. Consequently, the
supernormal profit is distributed among the new firms and the total supply of output increases
in the market. This increase in supply reduces the overall price level in the market system.
Thus, as the equilibrium level drops, the profitability level declines to a normal level. Thus,
new firms continue to enter the competitive market until the existing firms’ starts earning
zero or normal profit. This is the reason behind the long-run economic profit of perfectly
competitive firms.
Answer to 2
In the long-run, firms functioning under a perfectly competitive market enjoys normal
or economic profit. This is because there is the absence of restrictions on entry and exit of
producers in and out from a perfectly competitive market scenario. Thus, firms are attracted
by the supernormal profit earned by the market operators in the short-run and enter the
market system leading to a division of profits. Similar to this, firms earning losses in the
short-run induces existing to exit the market in the long-run. However, the firms whose cost
curves lies at the lowermost point in the long-run average cost curve does not exit the market.

2ECONOMICS QUIZ
The firms leaving the industry continues to exit until Price equalizes with the marginal cost
and average cost. Apart from this, in the long-run competitive firms enjoys complete
efficiency by optimal allocation of available resources. The equalizing point of price and
marginal cost indicates this allocative enhancement. Additionally, there is technological
innovation due to knowledge spillover and firms can achieve efficiency in production. Thus,
the firms that are operating at the minimum point of average cost curve attains productive as
well as technical efficiency. However, the firms that fail to operate at this minimum point
exits from the market in the long-run.
Answer to 3
The characteristics or the assumptions of perfect competition are irrelevant in a real-
world scenario. The assumption of selling identical or homogeneous products indicates a
theoretical base. This is because, in real life, no firms sell identical products; they might be
selling products falling in the same category but with a difference in packaging and chemical
composition. Moreover, there is the absence of firms that accepts the market prices.
Producers or organizations decide different prices to dominate the market share. Thus, all the
firm together having equal market capitalization is another myth. The buyers’ do not accept
the prices of the market because they have other firms to choose from and retains their
bargaining power. Furthermore, buyers and the entire market participants do not have
complete information and knowledge about the market system. There is presence information
hiding along with the presence of transportation costs. Additionally, market structure has a
certain degree of restriction to entry and exit. New firms cannot readily enter a market
because there are substantial start-up costs and the existing dominant firms are a real threat to
such emerging firms in the real world. Therefore, neither producers nor buyers are flexible in
a real-life market scenario. Thus, a perfectly competitive market system does not exist in
reality.