Question

Perfect Competition (15)

1. What is unique about perfect competition as a market structure that sets it apart from the other three market structures we cover in this course? How does it affect the diagrams that we use to analyze firm behavior? (4)

Answer 1

Solution -

Perfect competition is a market structure where the price competition is so intense that maximumefficiency in resource allocation is obtained. There are many firms in perfect competition that areoffering a homogeneous product. Perfect competition is unique because the demand curve is horizontal, perfectly elastic. Typically in other market structures, the demand curve would slope downward. In perfect competition the individual producer is a price taker. There are many consumers in the market and no one is powerful enough to affect the market price, therefore consumers are also price takers. Producers have the ability to very easily enter and exit this market with little costs. Since a perfectly competitive firm is a price taker and its demand curve is horizontal, a firm doesn’t have the ability to raise the price of the product without losing all its customers to competitors or new entrants. There is also no reason for firms to lower their price since they can sell all they want at the going price. With perfect competition, demand equals the marginal revenue which equals the price

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