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2. (a) (i) State and explain three assumptions underlying the theory of imperfect competition - Leaving Cert Economics - Question 2 - 2014
Question 2
2. (a) (i) State and explain three assumptions underlying the theory of imperfect competition. (ii) Explain why a firm’s demand curve under imperfect competition ... show full transcript
Worked Solution & Example Answer:2. (a) (i) State and explain three assumptions underlying the theory of imperfect competition - Leaving Cert Economics - Question 2 - 2014
Step 1
State and explain three assumptions underlying the theory of imperfect competition.
Answer
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There are many buyers: An individual buyer, by his/her own actions, cannot influence the market price of the goods.
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There are many sellers in the industry: An individual seller can influence the quantity sold by the price it charges for its output.
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Product differentiation exists: The goods supplied by the firm are not homogeneous but are close substitutes. Firms use branding to distinguish their products from one another.
Step 2
Explain why a firm’s demand curve under imperfect competition differs from a firm’s demand curve under perfect competition.
Answer
In perfect competition, the demand curve facing a firm is horizontal or perfectly elastic (D=AR=MR). This is because each firm sells an identical product and any attempt to raise the market price will lead to a complete loss of customers to identical products of competitors.
In contrast, the demand curve facing a firm in imperfect competition is downward-sloping. This is due to product differentiation, where each firm offers a distinct product. As the firm increases its price, there will be a reduction in demand, as some consumers will switch to rival firms’ products (close substitutes).
Step 3
Explain, with the aid of a diagram, the long run equilibrium of a firm in imperfect competition.
Answer
The long-run equilibrium occurs at point X, where MC = MR. At this point, the firm produces Q2 units of output, and the price it charges is P2. The average cost of production at this level of output is represented by point C, where AC = AR, meaning there are normal profits for the firm.
This scenario can be represented in a diagram showing the intersection of the Marginal Cost (MC) and Marginal Revenue (MR) curves.
Step 4
With reference to your diagram in (b) (i) explain why the firm is not making socially efficient use of scarce resources.
Answer
An imperfectly competitive firm does not produce at the socially efficient output level on its AC curve, point W. This is because it is not producing at the lowest point of the average cost curve, leading to potential excess capacity.
The price exceeds the marginal cost of production, which represents the deadweight loss. This difference between price and marginal cost reflects a degree of monopoly power that the firm exercises in the market for its differentiated product, resulting in inefficiency.
Step 5
Suggest a market structure which most closely reflects the situation.
Answer
The market structure that most closely reflects the situation of a few large retailers dominating the Irish grocery market is Oligopoly.
This is characterized by a small number of firms with significant market share, high barriers to entry, and mutual interdependence among firms regarding pricing and production strategies.