The Firm in Pure Competition

A purely competitive market is characterized by a large number of relativelysmall firms. No single firm can influence the market price and are considered price takers.

In Figure graphs representing a purely competitive marketand one firm are shown.Panel represents the market. DM and SM represent the market demandand supply functions. If the market is in equilibrium the equilibrium price andquantities are PEM and QEM respectively. Notice that the quantity measuredalong the Q-axis in Panel A represent large quantities.

Panel represents a single firm in the market. Note that the quantity measured along the Q-axis in Panel B is small relative to that in Panel A. The firm accounts for a very small portion of the goods offered for sale in the market. Since there are a large number of firms in the market with identical or homogeneous products, buyers have no preference for any one firm’s product. The demand faced by a single firm is perfectly elastic at the market price. This is represented as a horizontal line at the price of PEM.

Remember that demand and AR coincide. Marginal revenue decreases at twicethe rate (has twice the slope of the AR) as a linear AR function. Since the slopethe AR for the purely competitive firm is 0, the MR does not decrease and liesalong the demand and AR functions.

Consider an increase in the market supply shown in Figure VII.3. The marketsupply function increases from SM to SM* in Panel A.VII.3. As a result, theequilibrium price (in Panel A) in the market falls from PEM to P*.

The equilibriumquantity will rise. Since the market price has fallen, the demand, AR and MRfunctions faced by the firm will fall to D*, AR* and MR*. Note that a decrease in market supply will shift the firm’s demand function up. An increase (decrease) in market demand would shift the firm’s demand up (down).

Changes in the conditions in the market alter the price. These changes in price provide information to the firms who then react to those changes.

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