Loading PDF...
Chapter Analysis
Intermediate16 pages • EnglishQuick Summary
This chapter on 'The Theory of the Firm Under Perfect Competition' explores how firms decide production levels to maximize profit. It introduces the concept of perfect competition characterized by many buyers and sellers, homogeneous products, and free market entry and exit. The chapter explains the revenue model under perfect competition, where prices equal both average and marginal revenues. Key topics include supply curves, profit maximization, and the impact of market dynamics on firm behavior .
Key Topics
- •Perfect Competition
- •Revenue and Cost Analysis
- •Profit Maximisation
- •Firm Supply Curve
- •Market Supply Curve
- •Impact of Taxes
- •Perfect Information
Learning Objectives
- ✓Understand the characteristics of perfect competition
- ✓Identify how firms maximize profits
- ✓Analyze the supply curve of a firm
- ✓Evaluate the impact of various economic factors on a firm’s output
- ✓Explore the relationship between price, average revenue, and marginal revenue
- ✓Examine the role of normal profit in firm sustainability
Questions in Chapter
What are the characteristics of a perfectly competitive market?
Page 68
How are the total revenue of a firm, market price, and the quantity sold by the firm related to each other?
Page 68
What is the ‘price line’?
Page 68
Why is the total revenue curve of a price-taking firm an upward-sloping straight line? Why does the curve pass through the origin?
Page 68
What is the relation between market price and average revenue of a price-taking firm?
Page 68
What is the relation between market price and marginal revenue of a price-taking firm?
Page 68
What conditions must hold if a profit-maximising firm produces positive output in a competitive market?
Page 69
Can there be a positive level of output that a profit-maximising firm produces in a competitive market at which market price is not equal to marginal cost? Give an explanation.
Page 69
Will a profit-maximising firm in a competitive market ever produce a positive level of output in the range where the marginal cost is falling? Give an explanation.
Page 69
Will a profit-maximising firm in a competitive market produce a positive level of output in the short run if the market price is less than the minimum of AVC? Give an explanation.
Page 69
Will a profit-maximising firm in a competitive market produce a positive level of output in the long run if the market price is less than the minimum of AC? Give an explanation.
Page 69
What is the supply curve of a firm in the short run?
Page 69
What is the supply curve of a firm in the long run?
Page 69
How does technological progress affect the supply curve of a firm?
Page 69
How does the imposition of a unit tax affect the supply curve of a firm?
Page 69
How does an increase in the price of an input affect the supply curve of a firm?
Page 69
How does an increase in the number of firms in a market affect the market supply curve?
Page 69
What does the price elasticity of supply mean? How do we measure it?
Page 69
Additional Practice Questions
Explain why the demand curve for a firm under perfect competition is perfectly elastic.
mediumAnswer: In a perfectly competitive market, the product is homogeneous, and there are many sellers. A firm is a price taker, meaning if it tries to charge a higher price than the market, it will lose all customers to competitors. Hence, the firm can sell any quantity at the market price, making the demand curve perfectly elastic.
Discuss how a firm calculates its profit-maximizing level of output.
mediumAnswer: A firm calculates its profit-maximizing level of output by equating marginal cost (MC) to marginal revenue (MR). If MR > MC, the firm increases production to maximize profit. If MR < MC, it reduces output.
What happens to a firm's supply curve if the government imposes a per-unit tax?
hardAnswer: A per-unit tax increases the cost of production, shifting the firm's supply curve to the left. This means the firm will supply a lower quantity at every price level as it seeks to maintain profitability.
Describe how a firm’s short-run supply curve is determined.
mediumAnswer: A firm’s short-run supply curve is determined by its marginal cost above the average variable cost. It is upward sloping because the cost of producing each additional unit rises as output increases.
Evaluate the impact of technological improvements on the supply curve of a firm.
easyAnswer: Technological improvements reduce production costs, enabling a firm to produce more output at the same price. This shifts the supply curve to the right, reflecting increased supply.
Can a firm under perfect competition influence the market price? Explain.
easyAnswer: No, a firm under perfect competition cannot influence the market price. Each firm is a price taker due to the presence of many sellers and buyers dealing in homogeneous products.
Explain what is meant by 'normal profit' and its role in a firm’s decision-making.
mediumAnswer: Normal profit is the minimum profit necessary for a firm to remain in business. It is considered a cost and reflects the opportunity cost of the resources employed by the firm.
What role does perfect information play in a perfectly competitive market?
hardAnswer: Perfect information ensures that all consumers and producers make optimal decisions because they have full knowledge about prices and products, ensuring rational buying and selling activities.
How does a firm decide when to shut down in the short run?
mediumAnswer: In the short run, a firm shuts down if the price falls below the minimum average variable cost because it cannot cover its variable costs, leading to losses exceeding fixed costs.
Discuss the relationship between marginal revenue and average revenue in a perfectly competitive market.
easyAnswer: In a perfectly competitive market, both marginal revenue and average revenue are equal to the market price because each extra unit sold adds exactly the market price to total revenue.