Question

A perfectly competative 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 consequence of a perfectly elastic demand curve on the marginal revenue recieved by the individual perfect competitor?

c.Based on your answers to b, state the profit optimizing rule (optimal Q) to as it applies to perfect competitor ONLY:

Answer 1

Ans.

(a) Demand curve is perfectly elastic in perfect competion because same price prevails in the market. The firms in the perfect competiton are price takers and the price is determined by the industry. As a result the additional units of a product are sold at the same price only and demand increases at the same price .

(b) The MR curve or Marginal revenue curve is same as the Demand curve. It is parallel to X-axis and overlapping the demand curve because as the additional units of a product are sold at the same price the marginal revenue recieved at every unit is same and it is equal to the price of the product only.

(c) The profit optimizing rule for perfect competition is that the firms maximize their profit at a output level where MC=MR i.e. marginal cost equals marginal revenue of firm because after this output level MC>MR which leads to losses because marginal cost is greater than marginal revenue and the firms revenue is not able to cover costs.