In order to perform either a graphical or algebraic analysis we must consider
the determination of demand and supply functions. It is important to distinguish
between the individual firm and the industry as a whole; we will discuss
the individual firm first.
a. The firm’s demand function
Wehave just seen that under the conditions of PC the firm will be a price-taker.
This means that each firm faces a perfectly elastic (horizontal) demand curve,
at the level of the prevailing market price. The economic interpretation of this
is that if the firm charges above the market price it will lose all its customers,
who will then buy elsewhere, and that there is no point in charging below the
market price, because the firm can sell all it wants, or can produce, at the
existing price. The level of the prevailing market price is determined by
demand and supply in the industry as a whole, as shown in Figure 8.1(i). The
demand curve in this case represents both average revenue (AR) and marginal
revenue (MR), since both of these are equal to the market price.
b. The firm’s supply function
This refers to the quantities of a product that a firm is willing to put onto the
market in a given time period at different prices. It can be seen that this