Chapter 8: Problem 11

A single firm in a perfectly competitive market is relatively small compared to the rest of the market. What does this mean? How small is small?

Short Answer

Expert verified

In a perfectly competitive market, a single firm is considered small if its share in the total market supply is negligible, meaning its production decisions do not significantly affect the overall market supply, demand, and price. Being a small firm in this context has several implications. The firm has no market power and must accept the market-determined price. Additionally, it faces a horizontal demand curve, indicating that it can sell its product at the market price regardless of the quantity produced, and its marginal revenue equals the market price. The term "small" here refers to the firm's relative influence on the market, rather than an absolute size or production capacity.

Step by step solution

Introduction to Perfectly Competitive Market

A perfectly competitive market is a theoretical market structure in which there are numerous producers and consumers, no barriers to entry or exit, and perfect information about the price and quality of goods. In such a market, all firms are price takers, meaning they have no influence over the market price, which is determined by the forces of supply and demand.

Small Firm in a Perfectly Competitive Market

In a perfectly competitive market, a single firm is relatively small compared to the rest of the market. This means that the firm's individual production and pricing decisions have a negligible influence on the overall market supply, demand, and equilibrium price. As a result, each firm must accept the market-determined price and cannot alter it.

Implications of Being a Small Firm

Being a small firm in a perfectly competitive market has several implications. First, the firm has no market power, meaning it has no control over the market price and must sell its products at the prevailing market price. Second, the firm faces a horizontal demand curve, which indicates that it can sell its product at the market price, regardless of the quantity it produces. Lastly, its marginal revenue equals the market price, as any additional goods sold bring in the same amount of revenue per unit.

How Small is Small?

In this context, the term "small" is not defined by an absolute size or production capacity. Instead, a firm is considered small if its share in the total market supply is negligible - meaning, its production decisions do not significantly affect the overall market supply, demand, and price. It is not about size in an absolute sense, but rather the individual firm's relative influence on the market as a whole. In a perfectly competitive market, there are so many firms that each one individually has an insignificant impact on the market.

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