Question

(a) Explain THREE (3) main characteristics of a perfectly competitive firm. [6 marks]

(b) Using an appropriate diagram, demonstrate how a perfectly competitive firm achieves equilibrium in the short-run. [7 marks]

(c) Why is the demand curve of a perfectly competitive firm horizontal? Explain your answer. [7 marks]

Answer 1

(a)

The three main characteristics of perfectly competitive market are

1. Large no of sellers and buyers- There are huge no of buyers and sellers in the market. So mush so that a single buyer or seller will not affect the market. A seller selling the product at a price lower than the market price will only hurt himself and will not affect the market.

2. Perfectly homogeneous product- The firms sell products which are perfect substitutes of each other. There is no way in which one can distinguish the two products from one another.The good has same size, shape and colour.

3. Firm is price taker. The price is set bu the industry and the firms are only price taker. It is the industry which decides the price in the market and firm takes it as is. The firm cannot charge more than or lower than the market price. If it does so it will only affect that firm only.

(b)

(c) The demand curve for the perfectly competitive market is horizontal and parallel to X-axis. This is because the price is constant. That is the firms are price takers. The price is set by the industry and firms charge it irrespective of the quantity demanded. That is the the elasticity of demand is infinity.