While discussing the assumptions of perfect competition, we have stated that under a perfect competition, the number of buyers and sellers are so large that an individual buyer or an individual seller cannot influence the market price.
A firm has to sell its products at the market price prevailing in the market. The buyers have also perfect knowledge of the quality and prices of the commodities which they wish to purchase. Similarly, a factor knows the reward which is paid to the similar factor in the country. In addition to these, the factors of production are perfectly mobile. They can freely move from one place to another place, from one occupation to another occupation, and no artificial barriers are imposed upon them by the state. The sellers sell identical and homogeneous goods.
Under the conditions stated above, there will be one price for the identical goods in all parts of the market. If any seller wishes to sell its goods at a price lower than the market price, its goods will be sold in time as all the buyers have perfect knowledge of the market. If he keeps the price higher than the market price, then goods will not be sold easily. The seller in order to get the maximum profit will have to sell its total output at the prevailing market price as is shown in the two diagrams, given below:
Diagram and Example:
In the fig. (14.1), market demand and supply curves intersect at point K. KL, i.e. $5 is the market price.
In the fig. (14.2), DD is the demand curve which an individual firm has to face. A firm whether it produces 5 units or 50 units has to sell its product at the prevailing market price, i.e., at $5. If at any time the aggregate demand rises, and the price settles at PR (i.e., $8), then an individual seller can sell its products at $8. He will face the new demand curve D/D/ as is shown in fig. (14.2).
Under perfect competition, the additional output is sold at the price at which, the first unit is sold. The average revenue curve is, therefore, always equal to marginal revenue and so both the curves AR and MR coincide.
For example, when the market prices of a commodity is $5 per unit, the firm sells 10 units. The total revenue of the firm is $50. If it wishes to sell 11 units, an individual firm cannot alter the market price. So it has to sell the additional units also at $5. The total revenue of the firm by selling 11 units will be $5. The addition made to the total revenue by selling one more unit, i.e.. MR is $5. The average revenue is also found by dividing the total revenue by the number of goods sold $( 50/10 = 5, 55/11 = 5, 60/12 = 5).
We therefore, find that under perfect competition marginal revenue, average revenue and price are the same. So these curves also coincide as is illustrated in the schedule and diagram given below:
The demand curve which a firm has to face in a perfect competitive market is a horizontal straight line parallel to the quantity axis.
The MR and AR curves coincide with the price line DD/.
Here MR = AR = Price as is shown in figure 14.3.