  Economics

# Perfectly Competitive Firms & Output Decisions

## Sarah Thomas

Subject Matter Expert

Learn what a perfectly competitive firm is, how they make output decisions, and how they determine the highest profit by comparing total revenue and total cost.

## What Is a Perfectly Competitive Firm?

A perfectly competitive firm (or a price-taking firm) is a firm that sells its goods or services in a market with perfect competition.

Some important facts about perfectly competitive firms are:

• It has no market power and no ability to set prices.

• The firm must accept whatever price the interaction of supply and demand sets in the market. This price is called the market price—also called the equilibrium price or the market-clearing price.

• So long as a perfectly competitive firm is willing to sell at the market price, the firm can sell any number of units it wishes to sell.

• The main output decision for a price-taking firm is the decision of how many goods or services to sell.

• To maximize profits, a perfectly competitive firm will choose a quantity where the market price is equal to marginal costs (P* = MC).

• For a perfectly competitive firm, the market price is equal to marginal revenue, so the firm’s profit-maximizing quantity is also the point where marginal revenue is equal to marginal cost (MR = MC).

## Why Are Perfectly Competitive Firms Price Takers?

Perfectly competitive firms are sometimes called price-taking firms or price takers because they must take the market price as given. Why is this the case?

In a perfectly competitive market, there are low barriers to entry and numerous firms competing to sell identical or very similar products. The immense amount of competition in the market makes it impossible for any single firm to set its own prices.

#### Problem 2

The following table shows total costs and total revenue for a firm at varying quantities of output. Fill out the last column in the table and determine which quantity of output is profit-maximizing for the firm.

 QUANTITY TOTAL REVENUE (TR) TOTAL COSTS (TC) TR-TC 20 $1,000$1,000 21 $1,050$1,025 22 $1,100$1,035 23 $1,150$1,130 24 $1,200$1,200

#### Problem 3

The following table shows costs and revenue for a firm at varying quantities of output. Which quantity of goods is profit-maximizing for this firm?

 QUANTITY TOTAL REVENUE MARGINAL REVENUE TOTAL COSTS MARGINAL COSTS 75 $7,500$100 $3,000$45 76 $7,600$100 $3,070$70 77 $7,700$100 $3,150$80 78 $7,800$100 $3,250$100 79 $7,900$100 $3,400$150

#### Problem 4

The graph shows perceived demand and marginal costs for a perfectly competitive firm. What quantity of goods should this firm sell in order to maximize profits?  #### Problem 3 Solution

The profit-maximizing quantity is 78. There are two ways you could answer this question. You could calculate profits using the total revenue and total costs in the same way you answered question 2. A simpler approach is to look for the point where marginal cost is equal to marginal revenue.

#### Problem 4 Solution

The level of output that will maximize profits is 40. This is the quantity that corresponds to the intersection of the perceived demand curve and the firm’s supply curve. It is the point where marginal cost is equal to marginal revenue (the market price).

#### Problem 5 Solution

The firm is incurring a short-term loss. We know this because average total costs exceed marginal costs at the profit-maximizing point.

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