Page 147 - DECO405_MANAGERIAL_ECONOMICS

Managerial Economics

Notes 6. Perfect mobility of factors of production: The factors of production are free to move from
one firm to another throughout the economy. It is also assumed that workers can move
between different jobs. Finally, raw materials and other factors are not monopolised and
labour is not organised.
7. Perfect knowledge: It is assumed that all the sellers and buyers have complete knowledge
of the conditions of the market. This knowledge refers not only to the prevailing conditions
in the current period but in all future periods as well. Information is free and cost less.
Market Condition

The assumptions of perfect competition imply that a particular relationship exists between the
firm and its market.
Figure 9.2(a) shows the market demand curve for a product. It shows the total amount of this
product demanded by consumers at different prices. It is a normal downward sloping demand
curve showing that for the industry as a whole quantity demanded increases as price falls.
Figure 9.2: Relationship between the Market and the Firm in Perfect Competition

Figure 9.2(b) shows the seller perceived demand curve which is horizontal, i.e., it is perfectly
elastic demand with respect to price. It hits the vertical axis at the current market price, P. Two
factors are stopping the producer from charging a price such as P , which is higher than P-perfect
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knowledge and homogeneous product. If a higher price is charged, customers would know
immediately that a lower price is available elsewhere, and that the product for sale at the lower
price is a perfect substitute for the more expensive product. The producer is also not undercutting
its rivals and charging a price, P which is lower than P. The firm's output is small compared to
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the industry as a whole and so its entire output can be sold at the current market price of P. At a
price lower than P the firm would not maximise its profit. Thus, over any feasible range of
output, the demand curve for the product of the individual firm is perceived to be horizontal.

Notes Equilibrium of the Firm
Firms aim to maximise profit and they can be in equilibrium only when they achieve this.
For all firms, profit maximisation is achieved when marginal revenue, (MR), equals
marginal cost (MC). If MR>MC, the firm adds more to revenue than it does to costs by
increasing output and sales. When this happens profits will rise. On the other hand, if
MR<MC, the firm adds more to costs than it does to revenue by expanding output and
sales. When this happens profits will fall. It follows thus, that the firm is in equilibrium
when MC=MR.

Contd...

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