The Theory of the Firm under Perfect Competition

The chapter on the theory of the firm under perfect competition talks about the Features of Perfect Competition, Price Taking Behaviour of the Perfect Competitive Market, the Supply Curve of a Firm, Price Elasticity of Supply etc.

Features of Perfect Competition :

It constitutes many buyers and sellers

The market is influenced by the size of the market, i.e., it consists of many buyers or sellers

Selling homogenous products adds another feature of perfect competition

No entry or exit fee for the firms i.e the firms are free to exit or enter the industry

Perfect flow of information between buyers and sellers about prices, quality, and other market aspects

Price Taking Behaviour of the Perfect Competitive Market:

A price taker is an individual who buys or sells products at the prevailing market price

A price-taking firm believes that if it sets a price above the market price, it will be unable to sell any quantity of the goods that it produces. However, if it sets a price that is less than or equal to the market price, the firm can sell as many units of the goods as it wants to sell

From a buyer’s end, a buyer will not purchase any products from the seller if the price is higher than the prevailing market price

Supply Curve of a Firm:

A firm’s ‘supply’ is the quantity that it chooses to sell at a given price, given technology, and given the prices of factors of production

On the X-axis, the supply curve of a firm shows the levels of output that the firm produces, whereas, on Y-axis, different market values are plotted. At the same time, factors like technology and prices of production remain unchanged

Supply is insensitive when the curve is vertical, and hence the elasticity of supply is zero. When there is a rise in price as well as in the supply, then the curve is sloped positively, and hence, the elasticity of supply is positive

The quantity that the firm’s supplies at the given price level can change without any corresponding change in the market price due to the change in other factors, such as:

Technological Progress: With the improvement in technology, firms’ output increases from the same amount of input and thus allowing them to sell more at the same market price. Due to an increase in supply, the curve shifts to the right
Input Prices: When the price of the input increases, then the firm sells less at the same Market Price, causing the supply curve to shift to the left and vice-versa in case of reduced input prices

Price Elasticity of Supply:

The ratio of the percentage change in quantity supplied to the percentage change in price

Measures the responsiveness of the number of goods supplied in the market with the changes in prices

If the supply of goods ceases completely when the price of the goods drops slightly, and the supply of the goods becomes infinite when there is even a little increase in the price of the goods, the supply is said to be perfectly elastic

If supply does not get affected due to a change in price, the supply is said to be perfectly inelastic

If the price of goods is exactly equal to the supply of goods in the market, the supply is said to be unitary elastic

Conclusion

A commodity with profit-making potential is not manufactured by a single company. Instead, several businesses compete with one another to draw clients to their brand. Because there are a large range of commodities with varying characteristics, the market for these commodities varies as well. One such categorization is perfect competition. Though it is, to a significant part, hypothetical, it is the most basic sort of market structure. Monopoly, monopolistic competition, oligopoly, and perfect competition are the four major kinds of market formation. A perfect competition industry structure is one in which several businesses produce homogenous goods. None of the enterprises is big enough to dominate the industry. A fully competitive market has small contributions from producers, perfect product knowledge, no transaction cost, equivalent goods, and no long-term economic profits.