Question

How does a perfectly competitive firm calculate total revenue?

Short answer

In a perfectly competitive market, a firm calculates its total revenue by multiplying the market price (P) by the quantity of the good sold (Q), where the firm has no influence over the market price and is considered a price taker. Total revenue = Market Price (P) × Quantity Sold (Q).

Step-by-step solution

Define Perfect Competition:

Perfect competition is a market structure in which many small firms produce identical products with no barriers to entry or exit. In perfect competition, individual firms have no influence over market prices, meaning that they are price takers and have to accept the prevailing market price for their products.

Firms as Price Takers:

In a perfectly competitive market, the individual firm views the market price for its good as given. The firm has no control over the price, and it can sell any quantity it wishes at the market price. Since there are many firms offering identical products, consumers have no preference for one firm over another. Therefore, an individual firm cannot charge a higher price than the prevailing market price; otherwise, consumers would purchase from their numerous competitors instead.

Calculating Total Revenue:

Total revenue is the amount of money a firm earns from selling its products. In general, a firm's total revenue is calculated by multiplying the price of the good (P) by the quantity of the good sold (Q): Total revenue = P × Q.

Application to Perfectly Competitive Firms

In the context of a perfectly competitive firm, the calculation for total revenue remains the same. The difference is that these firms cannot influence the market price (P). The firm takes the prevailing market price as given and simply sells the quantity (Q) it chooses to produce, which is based on where the marginal cost of production equals the market price. The total revenue is then calculated as: Total revenue = Market Price (P) × Quantity Sold (Q).