In many of my intermediate microeconomics quiz and test questions I encounter the term "competitive firm" and/or "perfectly competitive firm", e.g.: In the short run, a perfectly competitive firm earning positive economic profit is...

My textbook has no explicit definition for either of the terms. What assumptions should I make about:

  • The firm

  • The market the firm is operating in


Without seeing a particular context, it is hard to be 100% sure. But typically the term "competitive" is used as shorthand for "perfectly competitive".

A market is perfectly competitive if everyone in that market takes the price as given. That means a seller in a perfectly competitive market can sell as much or as little as he likes (and a buyer can purchase as much or as little as he likes) at the prevailing market price. Nobody has any power to influence the market price.

Contrast this with something like a monopolist, which can set whatever price it likes and therefore obviously does not take the price as given.

A firm in a perfectly competitive market would be said to be a "competitive firm".

  • $\begingroup$ The context included is as much as is given, that is a question from my midterm. Your answer is alluding that the assumptions should be about the market, not per say about the firm. $\endgroup$ – Owen Sechrist Nov 4 '15 at 19:24
  • $\begingroup$ An assumption that is often added for a firm is the capacity to cease operations when no profit are made, ie the firm always behave in an economically rational way. This is often not the case, even in markets where price are set in a perfectly competitive way. $\endgroup$ – VicAche Nov 5 '15 at 15:39

A Perfectly Competitive market is characterized by:

1) No exit or entry barriers
2) Totally homogeneous product
3) Eventually rising average cost of production
4) Suppliers and Consumers that are "price-takers", namely no individual action has any effect on the market price. This is rationalized by assuming that each producer and each consumer are "small" (as regards quantities) relative to the whole market.

If barriers existed firms could end up making pure economic profits. If product differentiation existed, each differentiated producer would face a downward slopping demand curve, i.e he would have some degree of monopolistic power. If average cost is eventually falling (doesn't happen very often though), the market will tend to become a "natural monopoly".

But the fourth property is the central one: in the real world there are always some barriers to entry/exit, and there is always some product differentiation, even if only in a broad sense. But as long as the market participants are small and with no visible monopoly/monopsony power (other than the little one offered through "inherent" product differentiation), the market will behave very much alike its theoretical ideal.

  • $\begingroup$ Too answer the question - A perfectly competitive, or competitive firm is a firm that behaves as it would under these conditions. $\endgroup$ – Jamzy Nov 6 '15 at 1:20
  • $\begingroup$ @Jamzy so should I assume, for example that the firm is operating at MC=MR? That's what I'm trying to get at: what assumptions do I make about the FIRM? That is what is needed to answer the questions such as the example I listed above. Part of the reason I am asking is because I keep getting questions marked wrong because there are multiple answers (on a multiple choice question) that are correct, so choosing the best answer is dependent on what assumptions one makes about how the FIRM is operating. $\endgroup$ – Owen Sechrist Nov 6 '15 at 15:20
  • $\begingroup$ @OwenSechrist In (most) economic models, firms are assumed to be profit maximizers, and this means that they always operate at $MR=MC$, except if some exogenous constraint makes the point infeasible. So this is not a characteristic that singles out a market structure and the firms in it. Properties 2), 3), 4) above pertain to the firm: identical, costly, and powerless. $\endgroup$ – Alecos Papadopoulos Nov 10 '15 at 0:19
  • $\begingroup$ @AlecosPapadopoulos thanks Alecos. That is helpful. The problem I keep running into is that in my int. micro class the professor uses multiple choice questions with multiple answers that are arguably correct. It's difficult to choose a "best" answer in these scenarios, especially without understanding any subtle implications of the terminology. I think my confusion would be better illustrated if I posted the multiple choices in my example question, but I don't want to be accused of asking homework/test questions. $\endgroup$ – Owen Sechrist Nov 11 '15 at 16:03

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