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The Theory of Firm Under Perfect Competition and Revenue

Last updated date: 16th May 2024
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Perfect Competition and Revenue

A commodity with profit-earning potential is not produced by one firm. Instead, numerous firms are competing with each other to attract customers towards their brand. As there are a wide variety of commodities which differ in characteristics, the market for these also differs. Perfect competition is one such classification. Though hypothetical to a large extent, it is the simplest type of a market form. The major types of market formation include monopoly, monopolistic competition, oligopoly, and perfect competition. Perfect competition is an industry structure in which many firms are producing homogeneous products. None of the firms is large enough to control the industry. The characteristics of a perfectly competitive market incorporate insignificant contributions from the producers, perfect information about products, zero transaction fee, equivalent products, and no long-term economic profits.

Perfect Competition

A perfectly competitive market has the following features:

  • The market includes a large number of buyers and sellers.

  • Each firm produces and sells a comparable product. i.e., the work of one firm cannot be differentiated from the effect of any other firm.

  • Entry into the market as well as exit from the market is free for firms.

  •  Information is perfect.

The existence of a large number of buyers and sellers means that each buyer and seller is very small compared to the size of the market. It means that no particular buyer or seller can influence the market by their size. Homogenous products further indicate that the creation of each firm is identical. So, a buyer can choose to buy from any firm in the market, and she gets the same product. Free entry and exit mean that it is easy for firms to enter the market, as well as to leave it. This condition is essential for the large numbers of firms to exist. If the entry was difficult, or restricted, then the number of firms in the market could be small. Perfect information implies that all buyers and all sellers are completely informed about the price, quality and other relevant details about the product, as well as the market.

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Total Revenue in a Perfect Competition

A perfectly competitive firm has only one major decision to make, i.e. what quantity to produce.

Profit = Total revenue − Total cost

        = (Price) (Quantity produced) − (Average cost) (Quantity produced)

A perfectly competitive firm must receive the price for its output as determined by the product’s market order and supply, it cannot choose the fee it charges. Rather, the perfectly competitive firm can decide to sell any quantity of output at the same price. It suggests that the firm faces a perfectly elastic demand curve for its product and buyers are willing to buy any number of units of output from the firm at the market price. When the perfectly competitive firm chooses what amount to produce, then the quantity along with the prices prevailing in the market for output and inputs will determine the firm’s total revenue, total costs, and level of profits.

Solved Examples on Revenue Under Perfect Competition

Q. Describe the Nature of Prices Prevailing in a Competitive Market.

Answer: In a competitive market, the prices are decided by the market forces of demand and supply. It means that no individual buyer or seller can control the cost of the commodity. The units can be sold only at a price fixed by the industry. In other words, the firm is a price taker, and the industry is a price maker. In essence, there are uniform prices in a competitive market for a commodity.

Q. What is a Market?

Answer: A market can be seen as a place where the producers and consumers of a commodity come in contact with each other. Buyers and sellers don't need to assemble at a particular home and make transactions happen. The most important condition is that producers and consumers should be able to communicate with each other. Market refers to the whole region where buyers and sellers of a commodity are in contact with each other to affect the purchase and sale of the entity.

FAQs on The Theory of Firm Under Perfect Competition and Revenue

1. What is profit maximization?

A firm produces and sells a certain amount of goods. The firm's profit, denoted by π 1, is defined to be the difference between its total revenue (TR) and its total cost of production (TC). So, π = TR – TC Clearly, the gap between TR and TC is the firm's earnings net of costs. A firm wishes to maximize its profit. The firm would like to identify the quantity q0 at which its profits are maximum. So, at any quantity other than q0, the firm's profits are less than at q0. For-profits to be leading, three conditions must hold at q0: 1. The price, p, must equal MC 2. The marginal cost must be non-decreasing at q0 3. For the firm to continue to produce, in the short run, the price must be greater than the average variable cost (p > AVC), and in the long run, the price must be greater than the average value (p > AC).

2. Define revenue under perfect competition.

In a competitive market, a firm believes that it can sell as many units of the good as it wants by setting a price less than or equal to the market price. Then there is no reason to put a price lower than the market price. In other words, the firm should desire to sell some amount of the good, the price that it sets is exactly equal to the market price. A firm earns revenue by selling the products it produces in the market. Let the market price of a unit of interest be p. If q be the quantity of the good produced, and sold, by the firm at price p. So, the total revenue (TR) of the firm is defined as the market price of the good (p) multiplied by the firm's output (q). Hence, TR = p × q.