Question

QUESTION 5

5.1 List FIVE (5) requirements for perfect competition to exist.

5.2 Explain why any firm maximises profit, or minimises losses, when marginal cost is equal to marginal revenue.

5.3 Explain the shape of the marginal revenue curve facing (a) a perfectly competitive firm and (b) a monopolistic firm. (10 marks

Answer 1

5.1

Following are the pre requisites for a perfect competition to exist

1. Large number of buyers and sellers: The first and foremost condition for a perfect competiton to exist is there should be large number of buyers and sellers. The number should be so large that no single buyer or seller is able to influence the price or output. A single buyer or seller should be like a drop in the ocean.
2. Homogeneous product: All the sellers in a perfect competition produces and sells similar product.In short,goods sold by sellers in a perfect competition are close substitutes of each other
3. Sellers are price taker:since there are large number of sellers in the market and the goods sold by them are close substitutes ,no single seller is able ti influence the market by increasing or decreasing the price,he has to accept the market price.
4. Free entry and exit of firms:There should be freedom of entry and exit of firm. Firms having hope of profit are free to enter the market at any time and also can leave the market whenever they wish.
5. Perfect knowledge of the market: Each buyer and seller has perfect knowledge of the market. In the sense that they possess complete knowledge prices at ehich goods are sold and bought.

5.2

Marginal revenue means change in the revenue when additional unit of a product is sold. while marginal cost is the additional cost when a unit of product is produced. Marginal revenue and marginal cost are used to determine amount of output and price per unit of commodity that will maximise profit.The point at which marginal revenue equals marginal cost,firm's profit is maximised.

Profit is total revenue less total cost.Given firms want to maximise profit,they should continue to produce as long as an additional unit adds more to revenue than it adds to the cost.Thus the firms should continue producing more output until marginal revenue equals marginal cost,the point where profits are maximised.

If the firm is producing at any point where marginal revenue is less than marginal cost of production,firm is producing too much.Itsrevnue from the additonal unit is less than the cost added by producing an additional unit. Hence it is likely to make loss. Hence in order to eliminate loss it should decrease its quanitity supplied until the point where marginal revenue equals marginal cost. While if the firm is producing at any point where marginal revnue is greater than marginal cost,the firm is not fully utilising its capacity and so as to earn more revenue and maximises its profit firm should increase its output until the point where marginal revenue equals marginal cost.

5.3

(a) Marginal revenue curve faced by a perfectly competitive firm

Under,perfect competiton there are large number of buyers and sellers where each buyer or seller is like a drop in the ocean and hence no single individual can influence the price or output in the market.Perfectly competitve firms are price takers and has to accept the market price for their product.Hence as there is uniformity in price under perfect competiton,Average revenue will be equal to marginal revenue.Therefore the marginal curve for a perfectly competitve firm is horizontal line or perfectly elastic and concides with the Average revenue curve.

(b) Marginal revenue curve faced by a Monopolistic firm

For a monopolistically competitve firm,Marginal revuenue curve is downward sloping and lies below the Average revuenue curve because A monopolist seller ordinary has to accept the lowest price for his prodcut in order to increase sales.