Question

A single firm in a perfectly competitive market is relatively small compared to the rest of the market. What does this mean? How "small" is "small"?

Short answer

In a perfectly competitive market, a single firm is considered relatively small compared to the rest of the market. This means the firm has limited ability to influence market price or output level, as its decisions do not affect overall market conditions. "Small" refers to the firm's negligible market share, production, and revenue compared to the total market. Being small in a perfectly competitive market implies limited market power, optimal production output, zero economic profit in the long run, and promotes both productive and allocative efficiency.

Step-by-step solution

Define Perfectly Competitive Market

A perfectly competitive market is a market structure in which there are a large number of firms producing a homogeneous product, and there are no barriers to entry or exit. In such a market, firms are price takers and they can only choose the level of output, given the demand curve they face.

Explain What it Means to be Relatively Small

In a perfectly competitive market, being relatively small means that a single firm has a very limited ability to influence the market price or output level as a whole. In other words, the firm's individual decisions will not affect the overall market and its conditions. The firm must accept the market price and adjust its production accordingly.

Discuss How Small is "Small"

"Small" in this context refers to the size of a firm relative to the market in terms of market share, production, and revenue. In a perfectly competitive market, each firm has a negligible market share, meaning their percentage of the total market output is extremely small. This ensures that individual firms do not have enough market power to influence the market price or the output of the whole industry.

Implications of Being Small in a Perfectly Competitive Market

The implications of being small in a perfectly competitive market include: 1. Limited market power: Firms cannot influence the market price, so they have to accept the price determined by the market forces of supply and demand. 2. Optimal production output: Firms can only decide their output level where their marginal cost is equal to the market price to maximize their profit. 3. Zero economic profit in the long run: Due to free entry and exit, new firms will enter the market when they perceive an opportunity to earn positive economic profits. This increased competition will eventually drive the price down, and the existing firms' economic profits will return to zero. 4. Efficiency: Perfectly competitive markets promote productive efficiency, as firms are forced to minimize their costs to stay competitive, and allocative efficiency, as they produce the optimal level of output where price equals marginal cost. By understanding the concept of being small in a perfectly competitive market, students can have a better grasp of market structure and the forces that shape firms' behaviors in various market conditions.