IGCSE Economics Paper-1: Specimen Questions with Answers 7 - 7 of 27

Question number: 7

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Essay Question▾

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Compare perfect Competition and imperfect competition. Explain the conditions of profit maximization of a firm.

Explanation

Perfect and Imperfect competition:

  • There are large number of buyers and sellers of a product in the market. Homogenous goods are sold under perfect competition. Buyers and sellers have perfect knowledge of the prevailing price of a product in the market. There are no restrictions on entry of new firms in the market. Nobody can affect the market price of the goods. It means that sellers and buyers are not so strong to affect the market price of goods. There is no need to spend on advertisement of the products.

  • But differentiated goods are sold under imperfect competition. There are large number of firms and buyers. Each firm has a limited control over the market. Each firm can spend on advertisement of its products in newspapers and television etc. Buyers prefer to purchase goods from specific seller of their choice. Sellers can change the price of goods at any time. Both average and marginal revenue curves are downward sloping because a firm will have to lower the price in order to sell more units of its product.

Condition of Profit Maximization

  • A firm will be in equilibrium, when profits are maximum. There are two conditions for the profit maximization and equilibrium of a firm. A firm always compares its marginal revenue with marginal cost. If , a firm will produce more units of a product. If , a firm will reduce production.

  • If , a firm will be in equilibrium at that level and it will not make any changes in the level of production. Though a firm is in equilibrium at the point where but its profits are not maximum. Under the second condition of equilibrium, MC must curve cut MR curve from below. At this point equilibrium, . It can be explained with the help of a diagram.

The Firm equilibrium

The Firm Equilibrium

  • In the diagram, production is given on X-axis and revenue and cost are given on Y-axis. Average revenue and marginal revenue are equal and AR and MR are coincided on line PP. At points F and E, marginal revenue is equal to marginal cost, as MC curve is cutting MR curve.

  • A firm is equilibrium at point E and produces ON units of output. If firm produces more than ON units of output, marginal cost will be more than marginal revenue and it will face losses.

  • At point E, marginal revenue is equal to marginal cost and marginal cost is cutting marginal revenue from below. A firm increases production from OM to ON because marginal revenue is greater than marginal cost and profits are maximum between the two points E and F.

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