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2. (a) (i) Explain the reason for the shape of the demand curve of an individual firm in perfect competition - Leaving Cert Economics - Question 2 - 2012
Question 2
2. (a) (i) Explain the reason for the shape of the demand curve of an individual firm in perfect competition. (ii) Outline two advantages of perfect competition. (... show full transcript
Worked Solution & Example Answer:2. (a) (i) Explain the reason for the shape of the demand curve of an individual firm in perfect competition - Leaving Cert Economics - Question 2 - 2012
Step 1
Explain the reason for the shape of the demand curve of an individual firm in perfect competition.
Answer
In perfect competition, the demand curve faced by an individual firm is perfectly elastic, which means it is horizontal at the market price. The firm is a price taker, as it cannot influence the market price due to its small size relative to the overall market. If the firm raises its price above the market level, it will lose all its customers, as consumers can easily switch to identical products offered by other firms.
Step 2
Outline two advantages of perfect competition.
Answer
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Low Prices: In a perfectly competitive market, firms sell their products at the lowest possible prices because competition drives prices down, benefiting consumers.
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Efficiency: Firms produce at the lowest point of their average cost curve, ensuring that resources are allocated efficiently without waste.
Step 3
Explain, with the aid of a labelled diagram, the equilibrium position of a firm in short run perfect competition.
Answer
In the short run, a firm in perfect competition reaches equilibrium where its marginal cost (MC) equals marginal revenue (MR), which also equals the average revenue (AR) at the market price. The diagram shows the MC and AC curves intersecting at a point where the firm maximizes profit. At this point, the price (P1) is above the average cost (AC), meaning the firm earns supernormal profits (SNP) at quantity produced (Q1).
Step 4
With the aid of labelled diagrams, explain the impact which the entry of new firms would have on the market and on the equilibrium position of the firm.
Answer
As new firms enter the market, the market supply increases, which causes the market price to fall from P1 to P2. The individual firm's demand curve shifts downward as well. Consequently, at the new equilibrium price (P2), the firm will produce a lower quantity (Q2), and supernormal profits will diminish as they are eroded by the influx of competition. The new equilibrium point will reflect a market where firms earn normal profits only.
Step 5
Contrast the characteristics of perfect competition with monopoly under the following headings: Barriers to entry.
Answer
In perfect competition, there are no barriers to entry, allowing new firms to enter freely and increase competition. In contrast, in a monopoly, barriers to entry exist, such as high startup costs or regulatory restrictions, preventing other firms from entering the market.
Step 6
Contrast the characteristics of perfect competition with monopoly under the following headings: Profits in the long run.
Answer
Firms in perfect competition can only earn normal profits in the long run, as new entries into the market eventually drive economic profits to zero. Conversely, monopolies can sustain supernormal profits indefinitely because they control the market and limit the entry of other firms.
Step 7
Contrast the characteristics of perfect competition with monopoly under the following headings: Economies of scale.
Answer
Firms in perfect competition typically do not benefit significantly from economies of scale because they are small relative to the overall market. In contrast, monopolies can often achieve substantial economies of scale by being the sole provider in the market, allowing them to lower average costs and maximize profits.