Perfect Competition

Question 1

Describe the point of short-run profit maximization for a firm in perfect competition.

Answer 1

Short-run profit is maximized where marginal revenue is equal to rising marginal cost; total revenue will exceed total costs by the greatest amount at that point.

Question 2

How are long-run profits determined for a firm in perfect competition?

Answer 2

There are no long-rum profits possible in a perfectly competitive market. If profits are made in the short-run, more firms will enter the market and increase supply, thus decreasing market price until all firms just break even.

Question 3

List the characteristics of perfect competition.

Answer 3

1. A large number of independent buyers and sellers, each of which is too small to separately affect the price of a commodity.
2. All firms sell homogeneous products or services.
3. Firms can enter or leave the market easily
4. Resources are completely mobile
5. Buyers and sellers have perfect information
6. Government does not set prices

Question 4

What is the shape of the demand curve for a firm in perfect competition?

Answer 4

The demand curve faced by a single firm in a perfectly competitive market is a straight horizontal line originating at the price set by the market (of all firms).

Question 5

What is a “price taker” firm?

Answer 5

The assumption that a firm in a perfectly competitive market must accept (“take”) the price set by the market and can sell any quantity of its commodity at that price. Thus, the demand curve faced by a single firm in perfect competition is a straight horizontal line at the market price.