Question

6. a)What assumptions are necessary for a market to be perfectly competitive? Why each of these assumptions seem important to you?

b. For a perfectly competitive firm following information are available: Q = 100 units; AC = Taka 25, AVC =Taka 10; P = Taka 20. Based on the on the information provide your recommendation for the firm.

Answer 1

A) Assumptions for market to be perfectly competitive:-

• large numbers of buyers and sellers in the market:- there is large number of buyers and sellers and also called the free market where no can influence the price in the market. Every seller supply a proportionate commodity so none of the sellers or buyers can influence the market price in this market. In this market the industry is the price maker and firms are the price taker. So once the price is determined no one can change it.
• Free entry and exit of the firm:- as it is the free market there is no barriers for new firms to enter in this market. Firms are free to leave or enter in the market at any time. If the industries or firms induced profits they can stay or the losses can be cause they leave.when the market is in positive profit, the new industries will attract leading to increase in supply and fall in price and profit. On the other hand if there is loss in the market it will lead to decrease in supply leading to increase in price and profit. Which means firms can earn normal profits now.
• homogenous products:- products sold in this market are homogenous as they are similar in colour, quality, weight. Because the products are homogenous that's why firms cannot change the price as it may lead to loss.as buyers treats thr products as same so they pay the same price for every product. Every firm must have to charge same price for the commodity.
• perfect knowledge of market:- this means that sellers and buyers have the perfect knowledge of the products in this market. All firms have equal technology so that the cost per unit of each firm would be same to mantain equal price.and it will lead to uniform profits.
• absence of transport cost:- it is assumed that there is no extra cost for transportation which can increase the price that the buyer is not willing to pay. As a result only one price continue in the market.
• demand curve js perfectly elastic:- as elastic demand means that there is no change in pricr even when demand contract or expands. Which exactly what this market are. Even when supply or demand falls or rise, the price for the product never change.

The following assumptions are important to mantain a ideal and constant price in this market. As this factors are most responsible for the price of this market. If one these factor change then it may affect the price as well as demand. For eg:- if there will be hetrogenous products in this market then it can cause fluctuation in the price as the products are not identical. So there should be homogenous products for it to be perfectly competitive market. As a name suggest perfectly competitive means buyers and sellers operate freely in this market. So all the assumptions should be there in this market.

B) from the above information:- we can recommend the firm on the basis of total revenue and total cost. For this:-

First, we have given AC and AVC and from this we can find out AFC which is 15. (Acc. To *AC=AFC+AVC*)

Then from this we can conclude TFC and TVC which is 1500 and 1000 respectively. (TFC= AFC×Q ad TVC=AVC×Q)

Finally we can have Total cost (TC) that is 2500.(TC=TFC+TVC)

Now for total revenue (TR) formula is :- TR= P×Q

Which is 20×100= 2000.

Now, we can compare them and conclude the recommendation for the firm

As we can see the total cost exceeds total revenue by 500 units. Which means that firms suffer losses. As cost are bigger than revenues in this market.as to recover it, thr firm cannot change their price but they can change their level of output. As the loss cannot be totally eliminated the profit maximizing firm will see at what output the total cost and revenue difference is less and the firm will take the action. It can increase or decrease their output to minimize the difference of TR and TC. And firm will soon be gaining normal profit which is (TR=TC).