Features of markets and profit maximization in perfect competition

Firms do not operate in a vacuum, they interact with their customers and with other firms. These interactions take place in markets and economics has developed models of markets that predict how firms will behave in certain situations. The three major markets are 1. Perfect competition, 2. Perfect monopoly, and 3. Monopolistic competition.

Perfect competition is the most intense form of market interaction and though it may be intense, it is not as rare as many would have us believe. Perfect competition is characterized by the following:

1.         There are many firms selling a homogenous product.
2.         There are many buyers.
3.         There are no barriers to entering or exiting the industry.
4.         Firms in the industry have no advantage over new entrants.
5.         There are no transaction costs.
6.         There are no externalities.
7.         Firms and buyers in the industry have complete information.

Given the assumptions of perfect competition, it is unlikely that a firm can unilaterally influence the market price of a good will be. Hence, firms are called price takers. This is because there is nothing that the firm can do unilaterally to raise or lower the price of the goods it produces.

Perfection competition, satisfying all five requirements, does not happen that often, but many industries can satisfy three or four of the assumptions, and the industry approaches perfect competition. Hence the model’s results are still valid and can lend insight into what happens in reality.

What is an example of a price taker? Major applications of this occur in agriculture. If you grow soybeans and you grow 50 acres of beans, your beans are no better than the thousands of other acres of soybeans and there is nothing you can do to command a higher price for your beans. You are a price taker.
From the fact that a firm is a price taker, we can look at the individual firm’s demand curve,
The firm faces a perfectly elastic demand curve (Recall that perfect elasticity implies that a percentage change in price will lead to an infinite percentage change in quantity demanded). If the firm harvests 60 acres of soybeans instead of 50 acres, it can sell the extra 10 acres at the same price, and it can do this forever at the prevailing market price. (Reality may not support this proposition, but recall that economic models are not supposed to exactly represent reality, but should approximate reality. Therefore this assumption of the model may not directly apply to reality).

The firm is a price taker and has to compare with other firms by mimicking what they do and trying to get ahead at the same time. Therefore, the competitive firm has to make some decisions if it continues to stay in the industry. A perfectly competitive firm has to make the following decisions:

1.         Whether to stay in the industry or leave it.
2.         Whether to produce or to temporarily shut down.
3.         How much to produce.

Assume that the firm wishes to stay in the industry and it is going to produce. We know that the firm wants to maximize profits, but how is it going to do that?
We know that for the firm:


Comments

Post a Comment

Popular posts from this blog

What is the Dynamic Theory of Profit

Image
Clark's Dynamic Theory of Profit And Its Criticism The Dynamic Theory of Profit is associated with the name of an American Economist, J. B. Clark. In the world of reality, according to J. B. Clark, profit arises only in a dynamic economy. An economy is said to be dynamic when there is a change in population growth or change in the method of production or a change in the consumer’s wants, etc. A society which is without these changes is called a static society. In a static society, only monopoly profits continue to exist. All other economic profits are gradually eliminated by competition. In a dynamic society, an entrepreneur is always confronted with continuous unpredictable changes in demand for his product. The variation in demand may take place due to changes in fashions, tastes, the standard of living, distribution of income, population, new inventions, international repercussions, technological advances, etc. A prudent entrepreneur will always keep an eye on future demand
Read more

Compare the anatomy of Bifacial and Isobilateral leaves

BIFACIAL LEAF: It is also called dorsiventral leaf. This leaf is more strongly illuminated on upper surface than on lower surface. This unequal illumination induces a difference in the internal structure between upper and lower sides. Its internal structure shows: (1)        Upper Epidermis This is single layer of cells with thick cuticle which checks excessive evaporation of water from the surface. It does not contains chloroplasts, stomata are also absent. (2)        Lower Epidermis This is also single layer but with a thin cuticle. It bears many stomata, two guard cells of which contain some chloroplast, none are present in the epidermal cells. Internal to each stomata is large cavity called respiratory cavity. Lower epidermis of leaf is meant for exchange of gases (oxygen and carbon dioxide) between the atmosphere and the plant body. Excess water also evaporates from lower epidermis. (3)        Mesophyll The ground tissue lying between upper epidermis and th
Read more

osmoregulation in terrestrial and aquatic animals

Mechanism of osmoregulation is very important for all groups of animals whether inhibting land or water. Unlike plant cells, animal cells when placed in hypotonic solution burst due to the continuous absorption of water. On the contrary they would shrink and die if constantly placed in hypertonic solution. Normally uptake and loss of water are in balance for proper survival of cell. (1)        Osmoregulation in terrestrial animals: Terrestrial animals are more likely to loose water by evaporation through their permeable surfaces exposed to amsophere. Among various animal groups only Arthropods and vertebrates became the most successful land dwellers. They have developed number of strategies to maintain osmoregulation of their body fluid. (a) Water proof external coverings: To prevent water loss through external surfaces, vertebrates like reptiles, birds and mammals have water proof keratinized epidermis. Similarly the insects have developed external water proof layer called
Read more