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The Theory Of The Firm Under Perfect Competition NCERT Textbook With Solutions Book PDF Free Download
Chapter 4: The Theory Of The Firm Under Perfect Competition
In order to analyze a firm’s profit maximization problem, we must first specify the market environment in which the firm functions.
In this chapter, we study a market environment called perfect competition. A perfectly competitive market has the following defining features:
- The market consists of a large number of buyers and sellers
- Each firm produces and sells a homogenous product. i.e., the
product of one firm cannot be differentiated from the product
of any other firm.
- Entry into the market as well as exit from the market are free
- The information is perfect. The existence of a large number of buyers and sellers means that each individual buyer and seller is very small compared to the size of the market. This means that no individual buyer or seller can influence the market by their size. Homogenous products further mean that the product 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.
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.
These features result in the single most distinguishing characteristic of perfect competition: price-taking behavior.
From the viewpoint of a firm, what does price-taking entail? 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 good that it produces.
On the other hand, should the set price be less than or equal to the market price, the firm can sell as many units of the good as it wants to sell.
From the viewpoint of a buyer, what does price-taking entail? A buyer would obviously like to buy the goods at the lowest possible price. However, a price-taking buyer believes that if she asks for a price below the market price, no firm will be willing to sell to her.
On the other hand, should the price asked to be greater than or equal to the market price, the buyer can obtain as many units of the good as she desires to buy.
Price-taking is often thought to be a reasonable assumption when the market has many firms and buyers have perfect information about the price prevailing in the market.
Why? Let us start with a situation where each firm in the market charges the same (market) price.
Suppose, now, that a certain firm raises its price above the market price. Observe that since all firms produce the same good and all buyers are aware of the market price, the firm in question loses all its buyers.
Furthermore, as these buyers switch their purchases to other firms, no “adjustment” problems arise; their demand is readily accommodated when there are so many other firms in the market.
Recall, now, that an individual firm’s inability to sell any amount of the good at a price exceeding the market price is precisely what the price-taking assumption stipulates.
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NCERT Solutions Class 12 Economics Chapter 4: The Theory Of The Firm Under Perfect Competition
1. What are the characteristics of a perfectly competitive market?
A perfectly competitive market exhibits the following characteristics.
i) There are many sellers and buyers in every category.
ii) Multiple choices for similar products.
iii) Sellers or buyers are well-informed and are free to make decisions based on their knowledge of the market.
iv) All the products are homogeneous. Because every product has the same properties, a uniform price can be achieved.
v) There is no price control and the producers can set the prices as per the market demands and supply chains available.
vi) There is no extra cost due to marketing or advertising.
vii) All companies have access to the market without any transport cost.
2. How are the total revenue of a firm, market price, and the quantity sold by the firm related to each other?
The total revenue of a firm is the sum of all revenue earned by the firm. The market price is the price under which the product is sold in the market. In an ideal scenario, the company can control the market price by determining the amount of output that gets sold. And thereby, the company dictates its own scale of revenue.
3. What is the ‘price line’?
A price line or a budget line represents the various combinations and possible quantities of two goods that can be purchased with a given income and assumed prices.
4. Why is the total revenue curve of a price-taking firm an upward-sloping straight line? Why does the curve pass through the origin?
For a price-taking firm, the Average Revenue (AR) is always constant. When AR is constant, Marginal Revenue (MR) is also constant.
This means that the Total Revenue (TR) of the firm increases in the same proportion when the price is also constant. Therefore, we see a TR curve that slopes upward as a straight line. When the output level is zero, the TR curve passes through the origin.
5. What is the relation between market price and the average revenue of a price-taking firm?
The average revenue of a price-taking firm is equal to its market price.
NCERT Class 12 Economics Textbook Chapter 4 With Answer PDF Free Download