Perfect Competition and Revenue
A commodity with profit-earning potential is not produced by one firm. Instead, numerous firms are competing with each other to attract customers towards their brand. As there are a wide variety of commodities which differ in characteristics, the market for these also differs. Perfect competition is one such classification. Though hypothetical to a large extent, it is the simplest type of a market form. The major types of market formation include monopoly, monopolistic competition, oligopoly, and perfect competition. Perfect competition is an industry structure in which many firms are producing homogeneous products. None of the firms is large enough to control the industry. The characteristics of a perfectly competitive market incorporate insignificant contributions from the producers, perfect information about products, zero transaction fee, equivalent products, and no long-term economic profits.
Perfect Competition
A perfectly competitive market has the following features:
The market includes a large number of buyers and sellers.
Each firm produces and sells a comparable product. i.e., the work of one firm cannot be differentiated from the effect of any other firm.
Entry into the market as well as exit from the market is free for firms.
Information is perfect.
The existence of a large number of buyers and sellers means that each buyer and seller is very small compared to the size of the market. It means that no particular buyer or seller can influence the market by their size. Homogenous products further indicate that the creation of each firm is identical. So, a buyer can choose to buy from any firm in the market, and she gets the same product. Free entry and exit mean that it is easy for firms to enter the market, as well as to leave it. This condition is essential for the large numbers of firms to exist. If the entry was difficult, or restricted, then the number of firms in the market could be small. Perfect information implies that all buyers and all sellers are completely informed about the price, quality and other relevant details about the product, as well as the market.
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Total Revenue in a Perfect Competition
A perfectly competitive firm has only one major decision to make, i.e. what quantity to produce.
Profit = Total revenue − Total cost
= (Price) (Quantity produced) − (Average cost) (Quantity produced)
A perfectly competitive firm must receive the price for its output as determined by the product’s market order and supply, it cannot choose the fee it charges. Rather, the perfectly competitive firm can decide to sell any quantity of output at the same price. It suggests that the firm faces a perfectly elastic demand curve for its product and buyers are willing to buy any number of units of output from the firm at the market price. When the perfectly competitive firm chooses what amount to produce, then the quantity along with the prices prevailing in the market for output and inputs will determine the firm’s total revenue, total costs, and level of profits.
Solved Examples on Revenue Under Perfect Competition
Q. Describe the Nature of Prices Prevailing in a Competitive Market.
Answer: In a competitive market, the prices are decided by the market forces of demand and supply. It means that no individual buyer or seller can control the cost of the commodity. The units can be sold only at a price fixed by the industry. In other words, the firm is a price taker, and the industry is a price maker. In essence, there are uniform prices in a competitive market for a commodity.
Q. What is a Market?
Answer: A market can be seen as a place where the producers and consumers of a commodity come in contact with each other. Buyers and sellers don't need to assemble at a particular home and make transactions happen. The most important condition is that producers and consumers should be able to communicate with each other. Market refers to the whole region where buyers and sellers of a commodity are in contact with each other to affect the purchase and sale of the entity.
FAQs on Firm Theory Under Perfect Competition: Revenue Insights
1. What does it mean for a firm to be a 'price taker' in a perfectly competitive market?
In a perfectly competitive market, a firm is a 'price taker' because it must accept the prevailing market price for its product. This happens because the market has a large number of buyers and sellers, all producing a homogeneous (identical) product. No single firm has the market power to influence the price, so it can sell any quantity of its output only at the price determined by the market forces of demand and supply.
2. How is Total Revenue (TR) calculated for a firm in perfect competition?
Total Revenue (TR) is the total amount of money a firm receives from selling its output. For a perfectly competitive firm, it is calculated by multiplying the market price (P) by the quantity of goods sold (q). The formula is TR = P × q. Since the price (P) is constant, the firm’s total revenue is directly proportional to the quantity it sells.
3. What is the relationship between Price, Average Revenue (AR), and Marginal Revenue (MR) for a firm under perfect competition?
For a firm in perfect competition, the relationship is very simple: Price = Average Revenue (AR) = Marginal Revenue (MR).
- Average Revenue (AR) is the revenue per unit, calculated as TR/q, which simplifies to the price (P).
- Marginal Revenue (MR) is the additional revenue from selling one more unit, which is also equal to the constant price (P).
4. Why are the Price, Average Revenue (AR), and Marginal Revenue (MR) curves the same for a perfectly competitive firm?
The Price, AR, and MR curves are identical for a perfectly competitive firm because the price is constant regardless of how many units the firm sells. Since the firm is a price taker, it receives the same price (P) for every single unit. This means the revenue per unit (AR) is always P, and the extra revenue from selling one more unit (MR) is also always P. Because all three values are constant and equal, they are represented by a single horizontal line parallel to the quantity axis.
5. What does the demand curve for an individual firm look like in perfect competition, and why is it important for understanding revenue?
The demand curve for an individual firm in perfect competition is a horizontal straight line at the level of the market price. This indicates perfectly elastic demand, meaning consumers are willing to buy any quantity from that firm at the market price. This curve is crucial because it also serves as the firm's Average Revenue (AR) and Marginal Revenue (MR) curve. It visually demonstrates that the price, AR, and MR are all equal and constant.
6. How does a firm use its revenue and cost information to find the profit-maximising level of output?
A firm maximises its profit by producing the quantity of output where its Marginal Cost (MC) equals its Marginal Revenue (MR). As per the CBSE syllabus, two conditions must be met for profit maximisation:
- MR = MC.
- The MC curve must be rising at the point of equilibrium.
7. If a firm in a perfectly competitive market can sell all it wants at the market price, why doesn't it ever lower its price to attract more customers?
A firm in perfect competition has no incentive to lower its price. Since it can already sell any quantity of its product at the prevailing market price, lowering the price would be irrational. It would not increase the quantity sold (as demand is already unlimited at the market price) but would decrease its total revenue and, consequently, its profits. For example, if the market price is ₹10, selling 100 units brings in ₹1000. Selling the same 100 units at ₹9 would only bring in ₹900, leading to a loss in revenue.
8. What are some real-world markets that come close to the model of perfect competition?
While a truly perfect market is a theoretical concept, some real-world markets exhibit its key features. The best examples are often found in agriculture. For instance, the market for commodities like wheat, corn, or rice involves numerous farmers selling an identical product, where no single farmer can influence the global price. Another close approximation is the stock market, where numerous buyers and sellers trade identical shares of a company, with prices determined by overall market forces.
