SummaryThe assumptions of the model of perfect competition ensure that every decision maker is a price taker—the interaction of demand and supply in the market determines price. Although most firms in real markets have some control over their prices, the model of perfect competition suggests how changes in demand or in production cost will affect price and output in a wide range of real-world cases. Show
A firm in perfect competition maximizes profit in the short run by producing an output level at which marginal revenue equals marginal cost, provided marginal revenue is at least as great as the minimum value of average variable cost. For a perfectly competitive firm, marginal revenue equals price and average revenue. This implies that the firm’s marginal cost curve is its short-run supply curve for values greater than average variable cost. If price drops below average variable cost, the firm shuts down. If firms in an industry are earning economic profit, entry by new firms will drive price down until economic profit achieves its long-run equilibrium value of zero. If firms are suffering economic losses, exit by existing firms will continue until price rises to eliminate the losses and economic profits are zero. A long-run equilibrium may be changed by a change in demand or in production cost, which would affect supply. The adjustment to the change in the short run is likely to result in economic profits or losses; these will be eliminated in the long run by entry or by exit. Concept Problems
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ReferencesBuckley, W. F., “Carey Took on ‘Greed’ as His Battle Cry,” The Gazette, 22 August 1997, News 7 (a Universal Press Syndicate column). How is the curve of marginal revenue in perfect competition market?In a perfectly competitive market, the marginal revenue is equal to price and price is constant. The MR curve is thus a horizontal line with slope equal to zero.
What does the total revenue curve look like for a perfectly competitive firm?Total revenue for a perfectly competitive firm is a straight line sloping up. The slope is equal to the price of the good. Total cost also slopes up, but with some curvature. At higher levels of output, total cost begins to slope upward more steeply because of diminishing marginal returns.
What shape is marginal revenue in perfect competition?We have seen that a perfectly competitive firm's marginal revenue curve is simply a horizontal line at the market price and that this same line is also the firm's average revenue curve. For the perfectly competitive firm, MR=P=AR. The marginal revenue curve has another meaning as well.
What does marginal revenue for a competitive firm looks like and why?A competitive firm's marginal revenue always equals its average revenue and price. This is because the price remains constant over varying levels of output.
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