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Economics explained


Market structures

Perfect competition - Short run

Perfect competition - Short run

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In perfectly competitive markets:

The demand curve = The average revenue curve = The marginal revenue curve

In a perfectly competitive market, each firm passively accepts the market price, which becomes each firm's average revenue (AR) and marginal revenue (MR) curve. This is because a condition of perfect competition tells us that a perfectly competitive firm can sell as much as it wishes at the market's ruling price (P1). If the firm sells an additional unit of output, it will get the same price as the one before. Thus marginal revenue is equal to the price or the average revenue (D = AR = MR ).

Firms will produce where MR=MC

It is assumed that perfectly competitive firms will seek to maximise their profits. They will aim to maximise the difference between the total revenue and total cost. A perfectly competitive firm will thus produce at the profit maximising output where marginal revenue is equal to marginal cost ( MR=MC ). This means that the firm produces up to the point where the cost of making the last unit is just covered by the revenue from selling it.

The firm will be making an abnormal profit in the short run.

Abnormal profit is represented by the shaded area.

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