Question

What does it mean that firms in perfectly competitive industries are price takers? What assumptions are needed for a firm to be a price taker?

How do firms in perfectly competitive industries determine profit maximizing output? Include the profit maximizing rule in your response.

Answer 1

Firms under perfect competition are price takers in the sense that there are a large number of firms that do not have enough power to individually set the prices for their products. Thus, the industry prices are determined by the market demand and supply curves and the firms take this price as given.

The following assumptions are necessary for the firm to be a price taker:

(i) Large number of firms in the industry

(ii) Homogeneous commodities.

Profit-maximizing output under perfect competition is determined at a point where marginal revenue = marginal cost = price.

Profit function = P.Q - C(Q) where P = price, Q= quantity, C = cost

Taking the first derivative with respect to Q we get, MR = MC( = P)