9.2 The Theory of Perfect Competition Flashcards
What is perfect competition?
A market structure in which all firms in an industry are price takers, and in which there is freedom of entry into and exit from the industry.
The perfectly competitive market structure—usually referred to simply as perfect competition—applies directly to a number of markets, especially many agricultural and raw-materials markets. It also provides an important benchmark for comparison with other market structures.
What are the 5 assumptions of a perfectly competitive market?
- All firms are price takers, they accept the market price of their product.
- There are many buyers and sellers (Enough that no one firm can have an effect on the market.)
- They have a homogenous product. Their product is all more or less the same product.
- There are no barriers to entry or exit from this market.
- Perfect Info: They all have access to all the same information regarding the market that they are in,
What is a homogenous product?
In the eyes of purchasers, every unit of the product is identical to every other unit.
What does it mean when a firm is a price taker?
A firm that can alter its output and sales without affecting the market price of its product.
Thus, a firm operating in a perfectly competitive market has no market power. It must passively accept whatever happens to be the market price, but it can sell as much as it wants at that price.
What is the main difference between a demand curve in a perfectly competitive market and a non-perfectly competitive market?
Even though the demand curve for the entire industry is negatively sloped, each firm in a perfectly competitive industry faces a horizontal (Perfectly elastic) demand curve because variations in the firm’s output have no significant effect on market price.
The notable difference between a firm’s individual demand curve and a market demand curve in a competitive market.
The firm is nearly perfectly elastic but the market is quite inelastic.
What is Total Revenue? (TR)
Total revenue (TR) is the total amount received by the firm from the sale of a product. If Q units are sold at p dollars each,
TR=p×Q
What is Average revenue?
Average revenue (AR) is the amount of revenue per unit sold. It is equal to total revenue divided by the number of units sold and is thus equal to the price at which the product is sold:
AR = TR/Q = (p×Q)/Q =p
What is Marginal Revenue?
Marginal revenue (MR) is the change in a firm’s total revenue resulting from a change in its sales by 1 unit. Whenever output changes by more than 1 unit, the change in revenue must be divided by the change in output to calculate the approximate marginal revenue. For example, if an increase in output of 3 units is accompanied by an increase in revenue of $1500, the marginal revenue is $1500/3, or $500. [21]
MR= ΔTR/ΔQ
What is true when firms are price takers?
For a competitive price-taking firm, the market price is the firm’s marginal (and average) revenue
When the firm is a price taker, AR = MR = p.
