Economics » Perfect Competition » How Perfectly Competitive Firms Make Output Decisions

How Perfectly Competitive Firms Make Output Decisions

A perfectly competitive firm has only one major decision to make—namely, what quantity to produce. To understand why this is so, consider a different way of writing out the basic definition of profit:

\(\begin{array}{l}\text{Profit}=\text{Total revenue}-\text{Total cost}\hfill \\ \text{}=(\text{Price})(\text{Quantity produced})-(\text{Average cost})(\text{Quantity produced})\hfill \end{array}\)

Since a perfectly competitive firm must accept the price for its output as determined by the product’s market demand and supply, it cannot choose the price it charges. This is already determined in the profit equation, and so the perfectly competitive firm can sell any number of units at exactly the same price. It implies that the firm faces a perfectly elastic demand curve for its product: buyers are willing to buy any number of units of output from the firm at the market price. When the perfectly competitive firm chooses what quantity to produce, then this quantity—along with the prices prevailing in the market for output and inputs—will determine the firm’s total revenue, total costs, and ultimately, level of profits.

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