The assumptions of perfect competition, short-run and long-run equilibrium, the entry and exit of firms, and the efficiency properties of the model.

What this dot point is asking

AQA wants you to state the assumptions of perfect competition, draw and explain short-run and long-run equilibrium, explain how entry and exit drive profits to normal, and assess the efficiency of the model. It is the benchmark against which monopoly and oligopoly are judged.

Assumptions

Because the product is identical and information is perfect, any firm charging above the market price sells nothing, and there is no reason to charge below it. These assumptions are rarely fully met in reality, but agricultural and some financial markets approximate them.

Short-run equilibrium

In the short run the firm maximises profit where $MC = MR$. Because price is set by the whole market, at that output the firm can:

• earn supernormal profit if price (AR) is above ATC,
• earn just normal profit if $AR = ATC$, or
• make a loss if price is below ATC, continuing to produce in the short run as long as price covers average variable cost (the shut-down rule: shut down if $P < AVC$).

Long-run equilibrium

So in long-run equilibrium $\text{price} = AR = MR = MC = ATC$, with only normal profit earned, and the firm produces at the bottom of its ATC curve.

Efficiency

The long-run outcome is highly efficient. It is allocatively efficient because price equals marginal cost ($P = MC$), so the value consumers place on the last unit equals its cost of production. It is productively efficient because firms produce at the minimum of the ATC curve. However, the model is unrealistic, products are identical (no choice or innovation), and firms earn no supernormal profit to fund research, so dynamic efficiency may be poor compared with more concentrated structures.

Using perfect competition as a benchmark

Perfect competition is examined far more often as a comparison than in its own right, because it is the yardstick of efficiency. When you analyse monopoly, oligopoly or a market failure, the implicit question is how the outcome differs from the competitive ideal of $P = MC$ and production at minimum ATC. Knowing the model well lets you state precisely what is lost: monopoly restricts output and raises price, creating allocative inefficiency; oligopolists may keep prices sticky; and externalities drive a wedge between private and social outcomes that competition alone cannot close.

The model's realism is limited (truly homogeneous products and perfect information are rare), and because firms earn only normal profit in the long run they have little spare funding for research, so dynamic efficiency may be weak. This is the central trade-off in market structure analysis: more competitive markets tend to be statically efficient (low prices, no waste), while more concentrated markets may be more dynamically efficient (innovation funded by supernormal profit). A good evaluation weighs static against dynamic efficiency rather than assuming competition is always best.