Question

Briefly explain the reason for the shape of a marginal revenue curve for a perfectly competitive firm.

Short answer

The marginal revenue curve for a perfectly competitive firm is a horizontal line at the level of the market price. This shape is due to the firm being a price taker in the market and the additional revenue generated by selling one more unit is always equal to the prevailing market price, regardless of the number of units sold.

Step-by-step solution

Definition of Marginal Revenue

Marginal Revenue (MR) is the additional revenue generated by selling one more unit of a good or service. It can be calculated as the change in total revenue (TR) divided by the change in quantity (Q) sold, or MR = ΔTR/ΔQ.

Characteristics of Perfectly Competitive Market

A perfectly competitive market has the following characteristics: 1. Many buyers and sellers: There are a large number of buyers and sellers in the market, each having negligible market power. 2. Homogeneous products: All firms in the market produce identical goods or services, making them perfect substitutes. 3. Free entry and exit: New firms can easily enter or exit the market without any barriers or costs. 4. Perfect information: All market participants have complete information about the products, prices, and other market conditions.

Price Taker in Perfectly Competitive Market

In a perfectly competitive market, each firm is considered a 'price taker,' meaning that they cannot influence the market price; they accept the prevailing market price for their products. This happens because of the large number of firms and the homogeneous nature of the products. If a firm tries to charge a higher price, buyers will switch to the other firms offering the same product at a lower price. Hence, the demand curve for a firm in a perfectly competitive market is perfectly elastic (horizontal to the quantity axis) at the prevailing market price.

Deriving the Marginal Revenue Curve for a Perfectly Competitive Firm

Since the firm is a price taker in a perfectly competitive market, the additional revenue generated by selling one more unit is equal to the market price (P). Therefore, the marginal revenue (MR) will be equal to the market price. Mathematically, MR = ΔTR/ΔQ = P, as the price remains constant when the quantity sold changes.

Shape of the Marginal Revenue Curve for a Perfectly Competitive Firm

In conclusion, the marginal revenue curve for a perfectly competitive firm is a horizontal line at the level of the market price. It has this shape because the firm is a price taker in the market, and the additional revenue generated by selling one more unit is always equal to the prevailing market price, regardless of the number of units sold.