Question

A perfectly competitive firm is said to face a perfectly elastic demand curve

a.) Explain why the price elasticity is so high under perfect competition:

b.)What is the consequences of a perfectly elastic demand curve on the marginal revenue received

by the individual perfect competitor?

c.)ased on your answers to b, state the profit optimizing rule (optimal Q) to as it applies to

perfect competitors ONLY:

Answer 1

1.
a.
The price elasticity for a perfect competitor is very high this is because there is a large number of sellers and buyers in this market.The intersection of the downward sloping demand and upward sloping supply curve give the equilibrium price.This equilibrium price is taken as the demand curve for an individual firm.Thus, the demand curve is a horizontal line.An individual firm can sell as much as it wants at this price.If the firm charges any higher price the consumers will go to the other firm who is charging a market price.This is because the products produced by a competitive firm are homogenous.All the consumers would go to the firm with the lower market price and hence the firm will lose all its customer.Therefore the elasticity is very high.
b.
Since the market price is the demand curve for an individual firm the average revenue is the demand curve itself.Furthermore, since the demand curve is a horizontal line the marginal revenue is also equal to the average revenue and price.
c.
The profit maximizing equation is MC=MR for any firm and that MC should cut MR from below.However, since a competitive firm has P=MR therefore for this firm, in particular, the profit-maximizing equation becomes P=MC.