NCERT Book Class 12 Economics (Microeconomics) Chapter 4 The Theory Of The Firm Under Perfect Competition

Chapter 4
The Theor
Theoryy of the Firm
Firm
under Per
Per fect Competition
erfect

In the previous chapter, we studied concepts related to a firm’s
production function and cost curves. The focus of this chapter is
different. Here we ask : how does a firm decide how much to
produce? Our answer to this question is by no means simple or
uncontroversial. We base our answer on a critical, if somewhat
unreasonable, assumption about firm behaviour – a firm, we
maintain, is a ruthless profit maximiser. So, the amount that a
firm produces and sells in the market is that which maximises its
profit. Here, we also assume that the firm sells whatever it produces
so that ‘output’ and quantity sold are often used interchangebly.
The structure of this chapter is as follows. We first set up and
examine in detail the profit maximisation problem of a firm. Then,0
we derive a firm’s supply curve. The supply curve shows the levels
of output that a firm chooses to produce at different market prices.
Finally, we study how to aggregate the supply curves of individual
firms and obtain the market supply curve.

4.1 PERFECT COMPETITION: DEFINING FEATURES
In order to analyse a firm’s profit maximisation problem, we must
first specify the market environment in which the firm functions.
In this chapter, we study a market environment called perfect
competition. A perfectly competitive market has the following
defining features:
1. The market consists of a large number of buyers and sellers
2. Each firm produces and sells a homogenous product. i.e., the
product of one firm cannot be differentiated from the product
of any other firm.
3. Entry into the market as well as exit from the market are free
for firms.
4. Information is perfect.
The existence of a large number of buyers and sellers means
that each individual buyer and seller is very small compared to
the size of the market. This means that no individual buyer or
seller can influence the market by their size. Homogenous products
further mean that the product of each firm is identical. So a buyer
can choose to buy from any firm in the market, and she gets the
same product. Free entry and exit mean that it is easy for firms to
enter the market, as well as to leave it. This condition is essential