Perfect Competition

Perfect competition is the world of pric Halters. A perfectly competitive firm sells a homogeneous product (one identical to the product sold by others in the industry). It is 50 small relative to its market that it cannot .affect the market price;’ it simply takes theprice as given. When Farmer Smith sells a homogeneous product like wheat, she sells to a large pool of buyers at the .market price of $3 per bushel. Just as consumers must general accept the prices that are charged by Internet access providers or movie theaters. so must competitive firms accept the market prices of the wheat or oil that they produce. We can depict a price-taking perfect competitor by examining the way demand looks to a perfectly competitive firm. Figure I shows the contrast between the industry demand curve (the DD curve) and the demand curve facing a single competitive firm (the dd curve) . Because a competitive industry is populated by firms that are small relative to the market, the firm’s segment of the demand curve is only a tiny segment of the’ industry’S curve. Graphically, the competitive firm’s portion of the demand curve is 50 small that, to the lilliputian eye of the perfect competitor, the firm’s dd demand curve looks completely horizontal or infinitely elastic. Figure ~1 illustrates how the elasticity of demand for a single competitor appears very much greater than that for the entire market

The industry demand curve on the left shows inelastic demand at competitive equilibrium at A. However. tile per.’ feet competitor on the right sells to such a tiny part of the market that demand looks completely horizontal (i.e, per elastic). The perfect competitor can sell all it wants at the market price Because competitive firms cannot affect the price, the price for each unit sold is the extra revenue that the firm will earn. For example, at a market price of $40 per unit, the competitive firm can sell all it wants at $40. If it decides to sell 101 units rather than 100 units, its revenue goes up by exactly $40. Implant these key points in your long-term memory:

1. Under perfect competition, there are many small firms, each producing an identical product and each too small to affect the market price.

2. The perfect competitor faces a completely horizontal demand (or dd) curve.

3. The extra revenue gained from each extra unit sold is therefore the market price.

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