1.5.3 Perfect Competition — Practice Questions

Nine original multiple-choice questions on perfect competition, written to the style and difficulty of AQA Paper 3 Section A. Two ask you to sketch the diagram yourself. Every question carries a full worked model answer.

9 questions AQA A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 1.5.3 Perfect Competition revision notes.

1. 1. Which one of the following is not a characteristic of perfect competition?

   Definition in context

   Select one answer

   A Freedom of entry and exit.

   B Many buyers and sellers.

   C Perfect information.

   D Differentiated products.
   Show model answer

   Answer: D (Differentiated products.). Perfect competition has four defining characteristics: many buyers and sellers, homogeneous products, perfect information, and freedom of entry and exit. Products being differentiated is the opposite of the second condition — and it is precisely what distinguishes monopolistic competition from perfect competition.

   Why the other options are wrong

   • A — Freedom of entry and exit is essential. It is what drives supernormal profit away in the long run, as new firms are free to join whenever profits appear.
   • B — Many buyers and sellers is what makes each firm too small to affect the market price.
   • C — Perfect information means everyone knows all prices, so no firm could charge above the market price and expect to sell anything.

2. 2. Sketching the demand curve facing an individual firm in perfect competition, it will be

   Applied reasoning Sketch to solve

   Select one answer

   A Downward sloping, with marginal revenue lying below it.

   B Horizontal at the market price, so price equals MR.

   C Upward sloping, because higher prices attract more firms.

   D Vertical at the firm's capacity output.
   Show model answer

   Answer: B (Horizontal at the market price, so price equals MR.). Sketch price on the vertical axis and the firm's output on the horizontal. The firm is a price taker: it can sell as much as it likes at the ruling market price and nothing at all above it, because buyers have perfect information and every rival sells an identical product. The demand curve it faces is therefore horizontal — perfectly elastic — and since every extra unit brings in exactly the market price, P = AR = MR along that same line.
   Note the contrast with the market diagram, where industry demand slopes downwards as usual. It is only the individual firm's demand curve that is flat.

   Why the other options are wrong

   • A — This describes a firm with market power, such as a monopolist or a monopolistically competitive firm. A price taker has no ability to raise its price at all.
   • C — Demand curves slope downwards or, in this case, lie flat. An upward-sloping line would be a supply curve.
   • D — A vertical line means quantity is fixed whatever the price. The firm here can sell any quantity it chooses at the going price.

3. 3. In the short run, a firm in perfect competition finds that the market price is above its average cost at the profit-maximising output. The firm is

   Applied reasoning

   Select one answer

   A Breaking even, earning normal profit.

   B Making a loss and will shut down immediately.

   C Making supernormal profit.

   D Producing where marginal cost exceeds marginal revenue.
   Show model answer

   Answer: C (Making supernormal profit.). Price is the firm's average revenue. If AR is above AC at the chosen output, revenue per unit exceeds cost per unit, so the firm earns supernormal profit — the shaded rectangle in the standard diagram. This is entirely possible in the short run; what perfect competition rules out is sustaining it into the long run.

   Why the other options are wrong

   • A — Breaking even requires AR to equal AC. Here it is above.
   • B — A loss requires AR below AC, which is the opposite of what is described.
   • D — At the profit-maximising output, MC equals MR by definition. That is what makes it the profit-maximising output.

4. 4. Firms in a perfectly competitive industry are earning supernormal profit. Sketching the market and the firm side by side, the most likely long-run adjustment is

   Applied reasoning Sketch to solve

   Select one answer

   A New firms enter, market demand rises, the price rises and profit increases further.

   B Some firms leave, market supply falls, the price rises and profit increases further.

   C New firms enter, market supply rises, the price falls and profit returns to normal.

   D Nothing changes, because firms in perfect competition cannot alter their output.
   Show model answer

   Answer: C (New firms enter, market supply rises, the price falls and profit returns to normal.). Sketch two diagrams side by side: the market, and the individual firm facing a horizontal demand curve at the market price.
   Supernormal profit is a signal. Because there is freedom of entry, new firms join to capture it. In the market diagram, supply shifts right and the equilibrium price falls. In the firm diagram, the horizontal demand line drops with it, until price just touches the bottom of the average cost curve. At that point AR = AC, the firm earns only normal profit, and entry stops.
   This is why supernormal profit cannot persist in the long run under perfect competition — the absence of barriers to entry guarantees it is competed away.

   Why the other options are wrong

   • A — Entry adds to supply, not demand. More sellers pushes the price down, and it is that fall which removes the profit.
   • B — Firms leave when they are making losses. Profit attracts entry rather than exit.
   • D — Firms in perfect competition choose their own output — what they cannot choose is the price. Adjustment through entry and exit is the whole long-run mechanism.

5. 5. In long-run equilibrium, a firm in perfect competition earns

   Applied reasoning

   Select one answer

   A Normal profit, because entry and exit have removed any supernormal profit.

   B Normal profit, because firms agree not to compete on price.

   C Supernormal profit, because barriers to entry protect existing firms.

   D Supernormal profit, because the firm produces at minimum average cost.
   Show model answer

   Answer: A (Normal profit, because entry and exit have removed any supernormal profit.). Freedom of entry and exit is the engine. Supernormal profit draws firms in until it disappears; losses drive firms out until they stop. The only position in which neither happens is where AR = AC and the firm earns exactly normal profit. That is what makes it an equilibrium — nobody has any reason to enter or leave.

   Why the other options are wrong

   • B — Agreements not to compete are collusion, which belongs to oligopoly. With countless tiny firms selling identical products, collusion is impossible.
   • C — Perfect competition is defined by the absence of barriers to entry, which is exactly why supernormal profit cannot survive.
   • D — The firm does produce at minimum average cost in long-run equilibrium — that is productive efficiency — but at that point price equals average cost, so the profit is normal rather than supernormal.

6. 6. In long-run equilibrium, a perfectly competitive firm is

   Definition in context

   Select one answer

   A Allocatively efficient but not productively efficient.

   B Both allocatively and productively efficient.

   C Neither allocatively nor productively efficient.

   D Productively efficient but not allocatively efficient.
   Show model answer

   Answer: B (Both allocatively and productively efficient.). In long-run equilibrium the firm produces where P = MC, which is allocative efficiency: the price consumers pay for the last unit equals the cost of the resources used to make it, so the right quantity is being produced. It also produces at the lowest point on the average cost curve, where MC = AC, which is productive efficiency. Perfect competition achieves both simultaneously, which is why it serves as the benchmark against which other market structures are judged.

   Why the other options are wrong

   • A — Both conditions hold, not just one. Long-run entry pushes the firm to the bottom of its AC curve as well as to P = MC.
   • C — This is closer to the monopolistically competitive outcome in the long run, where the firm produces on the downward-sloping part of its AC curve and charges above marginal cost.
   • D — Again only half the picture. Being a price taker means the horizontal demand line is also the marginal revenue line, so profit maximisation delivers P = MC automatically.

7. 7. A firm in perfect competition raises its price slightly above the market price. All other things being equal, the most likely result is that

   Applied reasoning

   Select one answer

   A It loses some customers but keeps the most loyal ones.

   B Its rivals raise their prices to match.

   C Its total revenue rises, because the price is higher.

   D It loses all of its customers to rival firms.
   Show model answer

   Answer: D (It loses all of its customers to rival firms.). Two of the defining characteristics do the work here. Products are homogeneous, so buyers have no reason to prefer this firm, and information is perfect, so everyone immediately knows a cheaper identical product is available. Demand for the firm's output collapses to zero — which is exactly what a perfectly elastic demand curve means.

   Why the other options are wrong

   • A — Brand loyalty requires differentiation, and there is none. With identical products and perfect information there is nothing to be loyal to.
   • B — Each firm is far too small for its decisions to be noticed. Matching prices in response to a rival is oligopoly behaviour, driven by interdependence.
   • C — Revenue falls to zero, since no units are sold at all. A higher price only raises revenue if some customers remain.

8. 8. The market price in a perfectly competitive industry is £14. A firm produces 900 units at an average cost of £11. The firm's profit is

   Calculation

   Select one answer

   A £2,700 of supernormal profit.

   B £3,000 of supernormal profit.

   C £9,900 of supernormal profit.

   D Normal profit only, because price exceeds average cost.
   Show model answer

   Answer: A (£2,700 of supernormal profit.). In perfect competition the price is the firm's average revenue, so work in per-unit terms and then scale up.
   Profit per unit = AR − AC = £14 − £11 = £3.
   Total supernormal profit = £3 × 900 = £2,700.
   Because average cost already includes normal profit, everything above it is supernormal.

   Why the other options are wrong

   • B — £3,000 rounds the output to 1,000 units. The firm produces 900.
   • C — £9,900 is 900 × £11, which is the firm's total cost rather than its profit.
   • D — Price exceeding average cost is precisely the condition for supernormal profit. Normal profit only would require AR to equal AC.

9. 9. Perfect competition is described as a theoretical benchmark rather than a description of real markets. The best reason for this is that

   Applied reasoning

   Select one answer

   A Firms in real markets never try to maximise their profits.

   B Homogeneous products and perfect information rarely coincide.

   C Real markets always contain exactly one dominant firm.

   D Real markets cannot reach any form of equilibrium.
   Show model answer

   Answer: B (Homogeneous products and perfect information rarely coincide.). The model requires all four characteristics to hold at once, and two of them are especially demanding. Almost every real product is differentiated to some degree, by brand, location, service or quality, and buyers rarely have perfect information about every seller's price. The model is still valuable because it defines the efficient outcome — allocative and productive efficiency together — against which real markets can be judged.

   Why the other options are wrong

   • A — Profit maximisation is a reasonable approximation for many firms, and where it does not hold the alternatives are studied in their own right. This is not what makes the model unrealistic.
   • C — Most real markets contain several firms and many contain a great number. A dominant firm is one possibility among several structures.
   • D — Real markets do tend towards equilibrium; prices adjust to clear shortages and surpluses. The difficulty is with the model's assumptions, not with the idea of equilibrium.