1. Theory of the Firm Perfect Competition

2. Perfect competition Perfect competition is a theoretical market structure that will give the optimum allocation of resources. There are four conditions that have to be fulfilled for perfect competition to exist in an industry

3. Conditions • There must be many buyers and sellers and none of them can be large enough to have any influence over the market price • There must be perfect knowledge of the market (this means no advertising is necessary) • There must be no barriers to entry – firms must have complete freedom of entry and exit • The goods being sold must be homogenous in nature

4. If these conditions are met, then the industry is in perfect competition.

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6. Perfect Competition The lower price shifts the average revenue curve downwards until all the supernormal profit has been competed away, and the firms are making just normal profits. This long-run equilibrium is shown in the diagram below

7. In the short-run, it may be possible for an individual firm to make supernormal profit. This situation is shown in the diagram below, as the price (average revenue) is above the average cost (AC).

8. However, this supernormal profit will not last as it will attract new firms into the industry. The arrival of new firms shifts the supply curve to the right, as shown in the diagram below, and pushes the price down.