Question

Q) Perfect Competition

Demand: P=$4

Marginal revenue: MR = $4

Average total cost: ATC = 2/Q + Q

Marginal cost :MC = 2Q

Draw a graph showing MC. MR, demand, and ATC. Illustrate this firm's revenue, cost, and profit in your graph. Then, Explain why the demand is perfectly elastic in a perfectly competitive marker.

Answer 1

In perfect competition, P = MR = MC

2Q = 4

Q = 2

ATC = (2/2) + 2 = 1 + 2 = 3

Since P > ATC, firm is making Profit.

Profit = Q x (P - ATC) = 2 x (4 - 3) = 2 x 1 = 2

In perfect competition, each firm is too small to influence market price, so firms are price takers. They accept the market-determined price as its own price and sets this price equal to its MC. Since firm price is constant at market price, demand is perfectly elastic, and demand curve is horizontal at market price.

In following graph, profit is maximized at point A where P equals MC with output being Q0. Profit is area PABC.