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Perfect Competition - Essay Example

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It is common practice that we divide industries into categories pertaining to the level of competition in that industry. The spectrum of competition ranges from one extreme of perfect competition to the other extreme of monopoly…
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Perfect Competition
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Perfect Competition

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The model of perfect competition is based upon four assumptions. Firstly the firms are price takers. There are so many firms in the market that and single firm does not produce enough of the whole to be able to influence the market price. Therefore, they are considered as price takers where the price has already been determined at the market forces of demand and supply. There are no barriers of entry or exit for the firms. There are no stopping firms who wish to enter or leave the market. The existing firms have no role in this process. All firms are producing homogenous products. This means that the products of all firms are identical and as a result there can be no marketing in terms of names of brands. All the producers and consumers have perfect information regarding the prices of the products. Very few firms or industries come close to this model in the real world. We may see such conditions temporarily in the agricultural industry but, these do not exist in the long run. In perfect competition as stated in the assumptions above it is assumed that there are many small firms and that they cannot do anything to influence the market price. Therefore, they are considered as price takers where the price has already been determined at the market forces of demand and supply. There are no barriers of entry or exit for the firms. There are no stopping firms who wish to enter or leave the market. The existing firms have no role in this process. All firms are producing homogenous products. This means that the products of all firms are identical and as a result there can be no marketing in terms of names of brands. All the producers and consumers have perfect information regarding the prices of the products. (Sloman,2006) Very few firms or industries come close to this model in the real world. We may see such conditions temporarily in the agricultural industry but, these do not exist in the long run. In perfect competition as stated in the assumptions above it is assumed that there are many small firms and that they cannot do anything to influence the market price. The firm’s contribution to the industry and market is so small that even if it changes its output it will have no effect on the market price of the product. Thus, the firm can produce any quantity hoping to sell all of it at market price. Considering this it is derived that the demand curve is perfectly elastic and thereby, marginal revenue earned for each additional output sold is same throughout. Therefore, the marginal revenue is equal to average revenue (Bamford et al 2002.). Thus, considering that the individual firms do not affect the market price the only real decision which they have to make is the level of output to be produced. This decision can be taken by taking into account the costs of production. Considering the basic objective of the firm is to maximize profits it will produce at the point where marginal costs equals marginal revenue (MC=MR). (Bamford et al. 2002) The first thing which needs to be understood is the difference between the short run and the long run. During the short run the number of firms in the industry is fixed. This means that no new firms will be entering the market in the short run. The existing firms will have the chance to earn abnormal profits in the short run. However, in the long run there will be other firms entering the market. Firms will enter the market if there will be signs of abnormal profits. On the other hand, if there are losses some firms may also leave the industry. (Sloman,2006) The total revenue to be earned by the firm will be equal to the price multiplied by the quantity sold. If the total cost of producing this specified number of units is lesser than the total revenue then it can be said that the firm is making abnormal profits. This will actually be an incentive for the firm to keep producing at the current rate. However, if total revenue equals total coast (TR=TC), then the firm is barely making it to the breakeven point. It is this point where the firm is earning normal profits. On the other hand, it is plausibility that the total cost is greater than the total revenue. If the costs are greater, the firm may exit the industry altogether. This may not be the case at all times. If the total revenue is greater than ...Download file to see next pagesRead More
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