Chapter 4 – The Theory of the Firm Under Perfect Competition
Q1. What is perfect competition?
A market structure where many sellers offer identical products, no single buyer or seller can influence price, and there is free entry and exit.
Q2. What are the main features of perfect competition?
- Large number of buyers and sellers
- Homogeneous product
- Free entry and exit
- Perfect knowledge
- No transport cost
- Price taker firms
Q3. Why is a firm called a price taker in perfect competition?
Because the market determines the price, and individual firms have no control over it.
Q4. What is average revenue (AR)?
AR is revenue per unit sold:
AR = TR / Q, and under perfect competition, AR = Price.
Q5. What is marginal revenue (MR)?
MR is the additional revenue from selling one more unit of output:
MR = Change in TR / Change in Q
Q6. What is total revenue (TR)?
Total income from sales:
TR = Price × Quantity
Q7. What is the relation between AR, MR, and price under perfect competition?
AR = MR = Price, since price remains constant for all units sold.
Q8. What is the profit-maximising condition for a competitive firm?
MR = MC, and MC should be rising.
Q9. What is normal profit?
Minimum earnings to keep the firm operating, considered part of total cost in economic terms.
Q10. What is abnormal or supernormal profit?
Profit over and above normal profit, earned when TR > TC.
Q11. What is loss under perfect competition?
A firm incurs a loss when TC > TR — it may continue in short run if it covers variable costs.
Q12. What is the shutdown point?
The level of output where TR = TVC. Below this, the firm stops production in the short run.
Q13. What is the break-even point?
The point where TR = TC, resulting in zero economic profit.
Q14. Can a firm earn profit in the short run?
Yes, due to fixed supply and price rigidity, firms may earn supernormal profits or losses in short run.
Q15. What happens to profit in the long run under perfect competition?
Firms earn only normal profit due to free entry and exit, which eliminates abnormal profit or loss.
Q16. Why is long-run supply curve flatter?
Because firms can adjust all inputs, making supply more responsive to price changes.
Q17. What is the supply curve of a competitive firm in short run?
It is the rising portion of the MC curve above AVC.
Q18. What is market supply?
The total quantity supplied by all firms at different prices in the market.
Q19. What are increasing cost industries?
Industries where input costs rise with output, making long-run supply curve upward-sloping.
Q20. What is the role of MC curve in price decisions?
MC determines the level of output where MC = MR, ensuring maximum profit or minimum loss.
Q21. Why does a firm continue even in loss in short run?
If TR ≥ TVC, the firm covers variable costs and contributes to fixed costs, avoiding greater loss from shutdown.
Q22. What is equilibrium of a firm?
A firm is in equilibrium when it has no incentive to change output — occurs where MR = MC and MC is rising.
Q23. What is industry equilibrium?
When quantity demanded equals quantity supplied and all firms earn only normal profits.
Q24. What is the impact of free entry and exit in long run?
It ensures that only normal profits prevail, maintaining efficiency in resource allocation.
Q25. What happens if firms are earning supernormal profit in long run?
New firms enter, increasing supply and lowering prices until only normal profit remains.
Q26. What happens if firms incur loss in long run?
Loss-making firms exit, reducing supply and raising prices until firms earn normal profit.
Q27. Why is perfect competition efficient?
It leads to optimal allocation of resources, maximum consumer welfare, and no waste due to competitive pricing.
Q28. What is producer surplus?
Difference between what producers are willing to accept and what they actually receive.
Q29. What is allocative efficiency?
A state where resources are distributed in a way that maximises total societal welfare — achieved when P = MC.
Q30. What is productive efficiency?
It occurs when firms produce at the lowest possible cost — typically in the long run in perfect competition.