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A firm operating under conditions of perfect competition is a 'price taker' - Leaving Cert Economics - Question 2 - 2007
Question 2
A firm operating under conditions of perfect competition is a 'price taker'. Explain the concept of being a 'price taker'. With the aid of a labelled diagram, the e... show full transcript
Worked Solution & Example Answer:A firm operating under conditions of perfect competition is a 'price taker' - Leaving Cert Economics - Question 2 - 2007
Step 1
Explain the concept of being a 'price taker'.
Answer
In a perfectly competitive market, a firm is considered a 'price taker' because it has no power to influence the market price of its product. This is due to the following reasons:
- Market Structure: There are numerous firms producing homogeneous products. Each firm produces only a tiny fraction of the total market supply.
- Decision on Price: The firm must accept the market price determined by the overall supply and demand. If it attempts to charge more than the market price, it will lose all its customers to competitors.
- No Influence Over Price: Hence, the firm does not have the discretion to set its prices; it takes the price as given.
In summary, being a 'price taker' means that firms can only decide on the quantity to produce at the existing market price, effectively accepting the price set by the forces of supply and demand in the market.
Step 2
Explain, with the aid of a labelled diagram, the equilibrium position of a firm in short run perfect competition.
Answer
To analyze the equilibrium position of a firm in the short run under perfect competition, consider the following:
- Diagram: A typical equilibrium diagram includes the marginal cost (MC), average cost (AC), and demand (D = AR = MR) curves.
- Equilibrium Point: The firm will produce quantity Q1 at price P1 where the MC curve intersects the MR curve.
- Supernormal Profits: At this point, since P1 is greater than the average cost (AC), the firm earns a supernormal profit. The equilibrium condition is represented as:
At Q1, the firm will produce this output because profit maximization occurs when marginal revenue equals marginal cost.
Step 3
Explain the impact which the entry of new firms would have on the market and on the equilibrium position of this firm.
Answer
When new firms enter a perfectly competitive market, the following impacts occur:
- Market Supply Increase: The market supply curve shifts to the right (from S1 to S2). This change leads to a decrease in the market price from P1 to P2.
- Market Price Effects: As the price falls, the original firm will need to adjust its output to the new market price P2, resulting in a reduction in quantity produced from Q1 to Q2.
- Equilibrium Position Changes: The firm might still be producing at a level where average cost is greater than the new market price causing it to earn normal profits or even losses if it cannot cover its costs.
Therefore, the entry of new firms generally reduces profits and can force some firms to exit the market.
Step 4
Explain the term product differentiation.
Answer
Product differentiation is a marketing strategy employed by firms to distinguish their products from those of competitors. This can be achieved through:
- Branding: Establishing recognized and unique brands, such as Nike or Adidas, to create consumer loyalty.
- Competitive Advertising: Highlighting differences in products through various advertising strategies that appeal to consumer preferences, e.g., showcasing unique features.
- Product Innovation: Offering unique features that provide additional value, such as innovative packaging or advanced technology in product design. For instance, companies may promote their products as having better quality or enhanced functionality compared to competitors.
Ultimately, product differentiation allows firms to capture a larger market share despite having similar underlying products.
Step 5
Explain the effect of product differentiation on the AR and MR curves of a firm.
Answer
When a firm differentiates its products, the following effects on the Average Revenue (AR) and Marginal Revenue (MR) curves are observed:
- Downward Sloping Demand Curve: The AR curve will slope downwards from left to right. Unlike firms in perfect competition that face a horizontal demand curve, differentiated products allow firms to charge higher prices for unique offerings.
- MR Curve Behavior: The MR curve will also slope downwards but lies below the AR curve. As a result, if the firm lowers its price to increase sales, it will lose revenue on existing sales by selling at the new lower price (which applies to all units sold), leading to an overall decrease in MR.
In conclusion, product differentiation gives firms more pricing power, but it also complicates revenue management as they must balance price adjustments and sales volume.