Perfect Competition: Demand Curve

Demand Curve Facing a Perfect Competitive Firm

The demand curve of any firm shows the maximum price that consumers are willing to pay for different levels of quantity. Under perfect competition, the firm’s demand curve is perfectly elastic- a horizontal line parallels to the quantity axis.

The market demand curve, on the other hand, is conventionally downward sloping. To understand this distinction, it is essential to understand the difference between the market demand curve and the firm’s demand curve.

A firm’s demand curve gives the relationship between the ‘demand for the output of that particular firm’ and the ‘market price’. The market demand curve gives the relationship between the ‘total amount of industry output demanded’ and the ‘market price’.

The market demand curve is influenced by consumer behaviour, but the firm’s demand curve is influenced by consumer behaviour as well as other firms’ decisions. The firm’s demand curve is flat because every firm believes that it will be unable to sell anything at a price higher than the market price.

Moreover, if a firm charges a price lower than the market price, then the firm would get the entire market demand and would soon be ‘sold out’. After this, each of the other firms would be able to sell.

Further, the firm can sell any amount of the homogenous product at the ongoing market price. The firms in a perfectly competitive market are, thus, price takers. The demand curve facing a competitive firm will be given by a horizontal line facing the quantity axis as the firms are price takers, and prices will not change for change in output level.

To sum up, the ‘market price’ is determined by the interaction of the market demand and supply curves and is taken to be given for a single firm. This is because each firm is a small part of the industry, and its output decisions have a negligible effect on the ‘market price’.

Figure1 1
Figure1

The above figures show the industry and firm’s demand curve for a perfectly competitive market. In Figure (a), DD represents the industry demand curve. It is downward sloping as the consumers will buy more output at a lower price.

The intersection of the industry demand curve and the market supply curve yields the equilibrium market price as P* and the equilibrium quantity sold as Q*, which represents the total quantity produced by all the firms taken together.

Figure (b) shows the demand curve faced by a single perfectly competitive firm. It is a horizontal line at P* facing the quantity axis, implying that it can sell any additional unit of output without lowering the price.

As a result, when the firm sells an additional unit of output the total revenue (TR) rises by a fixed amount which is equal to the price of the product. Therefore, the marginal revenue (MR) and average revenue (AR) are equal to the price of the product.

The above figures illustrate how the intersection of market demand and supply curves of the industry determines the market price, which is taken as given by the firms. It is summarized in the table below:

TOTAL REVENUEAVERAGE REVENUEMARGINAL REVENUE
  TR = P*× QAR = 𝑇𝑅/𝑄 = 𝑃∗×𝑄 / 𝑄 = P*MR = 𝜕𝑇𝑅 / 𝜕𝑄 = P*

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