Why Is The Demand Curve Of A Firm In Perfect Competition Perfectly Elastic?

1420 words - 6 pages

Theoretically speaking four different market structures exists in today's world. Monopoly, oligopoly, imperfect competition and perfect competition are those four market structures. Monopoly and perfect competition are the two extreme cases, in monopoly the market is governed by one seller, and under perfect competition there are so many sellers that none of them has any power to control the market. As these two market structures are so extreme in nature, examples of these markets are very difficult to find in the every day world. Oligopoly and imperfect competition are the two common market structures and examples for them are easy to find in the real world. Oligopoly market structures usually consists of a very few firms in a given market and thus these firms enjoy quite a strong control over the market; example of an oligopoly would be OPEC.The perfectly competitive model relies on five basic assumptions. These assumptions stay the same regardless the fact whether the market under consideration is a product market or a factor market. The first four have to do with the supply side and the fifth assumption is concerned with the demand side. As outlined below the first assumption states that all firms in perfect competition are price taking firms.What is a price-taking firm? A firm is both a supplier and a demander; it is a supplier of the good it produces and a demander of the capital equipment that is required to start up in this industry. A price taking firm has two characteristics, one that no matter how much output it alters the firm cannot change the prevailing market price on that commodity, second that no matter how much capital equipment they demand it will be supplied to them at a fixed market prevailing price. The firms under perfect-competition are all price taking firms; reason being is the sheer volume of the firms in the industry. There are so many firms that no one has enough power to control over the market. For instance suppose there are 20 million firms in a given industry, each producing 20 units of output, and selling them at a given market price. Now suppose that one firm decides to double its output, the extra output the firm is producing has a negligent contribution to the total output of the industry, nevertheless the firm has doubled its output. Effectively speaking a firm in a perfectly competitive industry can produce as much output as it wants, and it still won't have any effect on the market price.Second assumption states that sellers cannot act strategically, supposing for instance in the wheat farming industry there are so many farmers. In choosing that how much crop they should produce, they don not need to care how much will some other farmer produces as this will not affect the farmers selling output. Contrary to this a strategic supplier will have to keep up with his rival firms, for example if Honda cars decide to reduce their price; they have to take into account the actions of other competitors like Toyota...

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