Question

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

Short answer

The shape of a marginal revenue curve for a perfectly competitive firm is a constant, horizontal line at the market price because the firm is a price taker with a perfectly elastic demand curve. This allows the firm to sell any quantity of its product at the market price without affecting overall sales, resulting in marginal revenue being equal to the market price for each additional unit sold.

Step-by-step solution

Define Marginal Revenue and Perfectly Competitive Firm

Marginal Revenue (MR) is the additional revenue generated by a firm when it sells one more unit of its product. In other words, it is the change in total revenue (∆TR) divided by the change in quantity (∆Q) produced. A perfectly competitive firm is a market participant that has no control over the price it charges for its products. The characteristics of a perfectly competitive market include a large number of buyers and sellers, identical products, perfect information, and no barriers to enter or exit the market.

Understand the Marginal Revenue Curve in a Perfectly Competitive Market

In a perfectly competitive market, firms are price takers, meaning they have no influence over the market price. As a result, the demand curve facing an individual perfectly competitive firm is horizontal, or perfectly elastic, at the prevailing market price. This implies that the firm can sell any quantity of its product at the market price without affecting its overall sales. Since the price remains constant regardless of the quantity sold, the firm's marginal revenue is equal to the market price for each additional unit sold. Therefore, the marginal revenue curve in a perfectly competitive market remains constant and is a horizontal line at the market price.

Explain the Reason for the Shape of the Marginal Revenue Curve

The reason for the shape of the marginal revenue curve (a constant horizontal line) in a perfectly competitive market is due to the firm being a price taker. Its demand curve is perfectly elastic, which means the firm can sell any quantity of its product at the market price without affecting the overall sales. As a result, the firm's marginal revenue is equal to the market price for each additional unit sold, leading to a constant and horizontal marginal revenue curve.