Perfect competition is a type of market structure where a large number of small firms producing identical products compete without any significant impact on prices or supply. There several factors which are followed in this particular model. Goods which are produced by the firms don’t have any product differentiation, in other words, they are homogenous and could substitutes each other in consumptions. As firms don’t have any market power and can’t influence prices due to their small size, rival companies won’t be following any changes in price, so customers are more likely to switch to another product which is the same and has a lower price if one product would become more expensive. It means that the demand for the product is very elastic. So each small firm is a ‘price taker’, and market sets the equilibrium price for the product. [pic]On the diagram which represents an industry a market supply curve intersects with market demand curve. The point of intersection is an equilibrium price. By looking at this diagram any small firm might decide to produce more output, as it will be insignificant for the market as long as the price will be the same for all of the output produced. So, as it is seen from the diagram representing firm’s supply, D=AR=MR. It means that if the firm will sell all of its output at the same price P, average revenue will be the same as marginal revenue-the extra revenue which comes from selling one more unit of output. In highly competitive market situation like perfect competition MR=Price, however, under imperfect competition for a profit maximizing company, MR might decrease as output will go up because the price will fall.
At point A on the diagram above, output is less than profit maximizing output Q*, so profit is less. At point B, profits will decrease because costs to produce the output are higher. So Q* is the output which a profit-maximizing company should produce. So companies operating under perfect competition don’t really...
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