ECON 201 CHAPTER 14 – FIRMS IN COMPETITIVE MARKETS In a perfectly competitive market all firms charge the same price for the good, and this price is determined by the interaction of all buyers and sellers in the market. The conditions for perfect competition are: 1. There are many buyers and sellers in the market, each of which is “small” relative to the market. 2. Each firm in the market produces a homogeneous (identical) product. 3. Buyers and sellers have perfect information. 4. There are no transaction costs. 5. There is free entry into and exit from the market. The above conditions ensure that each buyer and each seller in the market is a price taker. Since each firm is a price taker, as long as that firm charges a price equal to the market price, it can sell as much as it wishes. If the firm charged a price even only slightly above the market price, it would sell nothing. This means that the demand curve that a firm faces is perfectly elastic and is simply the market price. The Revenue of a Competitive Firm Recall that one of the goals of a manager is to maximize profits. Profits are equal to Total Revenues minus Total Costs. We already considered costs (Chapter 13). Let’s now address revenues. Total revenue = price times quantity (TR=P Q) ˣ Average revenue = Total revenue divided by the quantity sold (AR=TR/Q) Marginal revenue = Change in total revenue from an additional unit sold (MR= / TR Q D D ) Since a competitive firm can keep increasing its output without affecting the market price, each one-unit increase in Q causes revenue to rise by P . Therefore, AR=MR=P.