1. a.

The market structure is what categorizes different firms based on if

they sell homogenous or heterogeneous goods and on how they are
affected by external elements. Perfect competition is a theoretical
market structure in which all firms are price-takers, sell homogenous
product, have no barriers to entry or exit and have perfect knowledge.

If a firm is a price-taker, that means that it is very small and no one

can alter its own output enough to have a noticeable effect on the industry.
In this case, it cannot change the supply curve or the price. In perfect
competition, all the firms sell the same exact products. There is no
difference. They also have the right to enter and leave the market freely,
without having to be dependant on another markets. Finally, all producers
are fully aware of all the costs.

An example of perfect competition are foreign exchange markets.

Currency is homogenous, because each one is equal to another, there isn’t
one that has more value than another. We can also consider there to be
perfect knowledge, because anyone can access information about this
market.

The industry: The firm:

MC
Price ($)

Price ($)

AC

P P D=AR=MR

0 Q Quantity 0 q Quantity

b. In perfect competition, there are many small firms that each sell the
same products. If a firm makes abnormal profit, it means that the owner is
getting enough money to cover expenses and still has a lot left.

Making abnormal profit in perfect competition would be very hard.

Once a firm starts making abnormal profit and since in free competition
anyone can enter the market, there will quickly be new competitors. This
will lead to an increase in supply so decrease in the industry price. In
perfect competition, firms are price takers, so they will all have lower
prices, which means that the owners will have lower profit. Since the
owners will then be getting normal profit, they will then leave the market
and the firms will be producing less output than before the shift.

For example, there is a shop that sells phones for 800$. It takes 500$
to produce them, so the owner makes 300$ of profit for each phone they
sell. Since there aren’t many shops that sell these phones, many people
buy the product from this owner, leading to them making a large profit. In
order to make this much money as well, other people will open shops that
sell the exact same phone. As a result, people will start buying the phone
from other places, so the first owner will have less customers and the
phone factory will increase the production of the phone. It will then have
less value and since in perfect competition firms are price-takers,
everyone will start selling the phone for less money, they will sell it for 600$
for example. They now have a profit of 100$, which is one third of what
they used to get.

Price ($) MC

P D=AR=MR

Abnormal profit
C

0
q

That is an example of why it would be very hard to make abnormal

profit in perfect competition. Since anyone can enter the market, every
time abnormal profit starts to be made, new competitors will come,
leading to a decrease of profit. In conclusion, there will only be abnormal
profit for a short amount of time. It is impossible to have it in the long run.

2.
Price ($) Price ($)
MC S
AC
S1
P
D=AR=MR P
Abnormal profit
C
D1=AR1=MR1 P1
P1=C1
Quantity 0
0 q1 q Q Q1
 Abnormal profit is when a firm makes so much money that they have
enough to cover all of their expenses and still have a lot of money left.
Perfect competition is a theory in which there are many small firms that all
sell the same products, each firm is a price-taker, producers have perfect
knowledge and there are no barriers to entry or exit.

In perfect competition, it is impossible for a company to make

abnormal profits in the long run. That is because if a firm makes abnormal
profits in perfect competition, firms have the right to enter the market, so
many will enter in order to make the profit too. On the diagram, you can
see that at the original price, there is abnormal profit. However, at one
point, the supply will have to increase, which leads to a shift of the supply
curve to the right, like you can see in the second diagram. The industry
price will then decrease, so all the companies will sell their products for
less money. This will lead to all producers making normal profit again.

In conclusion, it is impossible for a firm to make abnormal profit in

the long run in perfect competition because every time this happens, many
competitors will enter the market and firms will make normal profit again.
Abnormal profit can only be made for a short amount of time.