Question

1A) Describe the difference between the market demand curve and each firm's individual demand curve in perfect competition.

1B ) For a perfectly competitive firm, the marginal cost curve is the same thing as that firm’s supply curve starting from the minimum point on the average variable cost curve because at every possible price; by finding the intersection of MR (where, MR = Price = Demand) & MC we find the quantity that will be produced. The description of how much is offered at each possible price is referencing Supply.

Answer 1

Answer to the question number 1A):

A market with perfect competition refers to a market in which each economic agent takes the market price as given and accordingly manage their economic activities. The condition of "given market price" is generally sustain in perfect competition due to prevelance of large number of buyers and sellers, homogeneous product, free entry and exist for the individual firms and perfect information about the prevailing price. Although the market price may be independent of agent's actions in perfect competition but the actions of all the agents together determine the market price. Thus equilibrium in a competitive market refers to a situation where the supply of goods of all the firms equals the demand.

From the above discussion, it is clear that a firm under perfect competition manages its operations by taking into account the price as given or fixed. So, essentially the demand curve faced by an individual firm under perfect competition becomes perfectly elastic at the ruling price in the market. Now let us explain these concepts of industry demand and individual firms demand with the help of following figures:

As shown in the above figure, initially the intersection between demand and supply curve at the perfectly competitive market sets the price at P0 and consequently the individual firms having no influence over the price will take the price P0 as given and therfore the demand curve or average revenue curve facing it will be a horizontal stratight line at P0. If any individual firm raises its price slightly above the ruling price, it will loose all its customers to its rivals. Similarly, the individulas firms will have no tendency to lower the price, as they could sell as much as they like at the prevailing price. The above figure also showed that an increase in the aggregate demand in the market (D0 TO D1) leads to increase in the price of products in a competitive market.

Thus to conclude, it is apperant from the above discussion that market demand curve in perfect competition slopes downeard but for the individual firms in perfect competition demand curve becomes perfectly elastic; as the indivial firms do not have any control control over the price.

Answer to the question number 1B:

We know that in a perfectly competitive firm, the equilibrium price and quantity is determined at the point of intersection between Marginal Revenue (MR) and Marginal Cost (MC). However, the relative position of equlibrium point along with other cost conditions determines whether an individual firm is making profit or loss. If the equilibrium point (where MR=MC) lies above the average cost at that specific price then the firm makes profit at that price. Let us explain this in detail with the help of a figure:

As shown in the figure, at the given price P, the individual firms are making profits; as the point E lies above L; (that is at the eqilibrium point MR> Average Cost). However, at the given price P1, the firms are facing losses. This is because the equilibrium point E1 indicates that at that price firms' MR< Average Cost. However, at that Price, P1, the firms may want to continue their production with economic losses, if they could cover their average variable cost (MR>AVC). However, if at a given price, the firms could not cover their Average Variable Cost (AVC) then they would leave the market at that market price.

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