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Chapter 8: Q12 (page 211)

What are the four basic assumptions of perfect competition? Explain in words what they imply for a perfectly competitive firm.

Short Answer

Expert verified

Perfect Competition, Assumptions : Large number of buyers and sellers, Identical Goods, perfect information, uniform prices, ease of entry & exit.

Step by step solution

01

Assumptions Concept 

Assumptions of Perfect Competition :

Large number of buyers and sellers in the market

Homogeneity of goods & services sold by all the sellers

Uniform price in the market taken by firm, no control of latter over price.

Perfect knowledge about all the aspects among buyers and sellers

Free entry and exit

02

Implications Explanation 

  • Large number of buyers and sellers have insignificant share of market supply & market demand, they cannot influence market price by altering their individual supply or demand.
  • Uniform price implies perfectly elastic horizontal demand curve, with infinite elasticity of demand & infinite selling capacity at constant price. No firm can sell at higher price.
  • Homogeneity of goods and services leads to buyers being indifferent among sellers and their goods & services.
  • Perfect Knowledge among buyers and sellers implies that all know about price, no seller is willing to sell at lower price & no buyer is willing to buy at higher price.
  • Free entry and exit leads to firms earning only normal profits and normal losses in long run. As super normal profits and abnormal losses are ruled out by market supply & price adjustment.

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Most popular questions from this chapter

How does a perfectly competitive firm calculate total revenue?

1. A computer company produces affordable, easy-to-use home computer systems and has fixed costs of \(250. The marginal cost of producing computers is \)700 for the first computer, \(250 for the second, \)300 for the third, \(350 for the fourth, \)400 for the fifth, \(450 for the sixth, and \)500 for the seventh.

a. Create a table that shows the company’s output, total cost, marginal cost, average cost, variable cost, and average variable cost.

b. At what price is the zero-profit point? At what price is the shutdown point?

c. If the company sells the computers for \(500, is it making a profit or a loss? How big is the profit or loss? Sketch a graph with AC, MC, and AVC curves to illustrate your answer and show the profit or loss.

d. If the firm sells the computers for \)300, is it making a profit or a loss? How big is the profit or loss? Sketch a graph with AC, MC, and AVC curves to illustrate your answer and show the profit or loss.

Explain how the profit-maximizing rule of setting P = MC leads a perfectly competitive market to be allocatively efficient.

What is a “price taker” firm?

A firm’s marginal cost curve above the average variable cost curve is equal to the firm’s individual supply curve. This means that every time a firm receives a price from the market it will be willing to supply the amount of output where the price equals marginal cost. What happens to the firm’s individual supply curve if marginal costs increase?
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