The Theory of the Firm under Perfect Competition Class 11: Revenue, Equilibrium and Supply

What The Theory of the Firm under Perfect Competition is about

Weightage: This chapter is part of Unit 6, Producer Behaviour and Supply, which carries 14 of the 80 theory marks in the school annual exam.Source: CBSE Economics (030) syllabus 2026-27, Class XI course structure, Unit 6 Producer Behaviour and Supply

Key concepts

Features of perfect competition

NCERT section 4.1

1. Very large number of buyers and sellers: each is too small to influence the market price.
2. Homogeneous product: all firms sell identical goods, so buyers have no reason to prefer one seller.
3. Free entry and exit of firms: in the long run, no abnormal profit or loss persists.
4. Perfect knowledge of market conditions among buyers and sellers.
5. (Also assumed: perfect mobility of factors; no transport costs.)

Result: every firm is a price taker. Price is set by market demand and supply; the firm can sell any quantity at that price but nothing above it. Its demand curve (AR) is perfectly elastic (horizontal) at the market price.

Real markets come close in agricultural produce (wheat in a large mandi) or some foreign-exchange and share markets.

Worked example

Why can a single wheat farmer not charge more than the market price?

Try it first, then show the solutionSolution

1. Wheat from all farmers is identical and buyers know the market price
2. If one farmer charges more, buyers simply buy from others

Answer: Because of homogeneous product, many sellers and perfect knowledge, he would sell nothing; he is a price taker.

Revenue: TR, AR and MR and their relationship

NCERT section 4.2

• Total revenue (TR) = P × Q.
• Average revenue (AR) = TR ÷ Q = price (in any market where all units sell at one price). The AR curve is the firm's demand curve.
• Marginal revenue (MR) = ΔTR ÷ ΔQ = TR_n − TR_(n−1). Also TR = ΣMR.

Under perfect competition (price constant at ₹15):

Output	Price = AR (₹)	TR (₹)	MR (₹)
0	-	0	-
1	15	15	15
2	15	30	15
3	15	45	15
4	15	60	15
5	15	75	15
6	15	90	15

AR = MR = P: both are the same horizontal line; TR is a straight line from the origin with slope equal to the price.

When price falls as more is sold (a downward-sloping AR, as for a firm that must cut price to sell more):

Output	AR = Price (₹)	TR (₹)	MR (₹)
1	20	20	20
2	18	36	16
3	16	48	12
4	14	56	8
5	12	60	4
6	10	60	0

Here MR < AR and MR falls faster than AR; TR rises while MR > 0, is maximum when MR = 0, and would fall if MR became negative. When AR is constant, AR = MR.

Worked example

A firm sells 8 units at ₹15 each. Find TR, AR and the MR of the 8th unit, under perfect competition.

Try it first, then show the solutionSolution

1. TR = 15 × 8 = ₹120
2. AR = 120 ÷ 8 = ₹15
3. MR₈ = TR₈ − TR₇ = 120 − 105 = ₹15

Answer: TR ₹120; AR = MR = ₹15 (equal to price).

Producer's equilibrium: profit maximisation (MR = MC)

NCERT section 4.3

A producer is in equilibrium when it earns maximum profit (or minimum loss) and has no reason to change output.

TR-TC approach: choose output where TR − TC is greatest.

MR-MC approach: two conditions:
1. MR = MC (under perfect competition, P = MC);
2. MC is rising at that point (MC cuts MR from below), so that producing more would cost more than it earns.

If MR > MC, producing one more unit adds more to revenue than to cost: expand. If MR < MC, cut output.

With price ₹15 and the cost schedule below:

Output	TR (₹)	TC (₹)	Profit = TR − TC	MR (₹)	MC (₹)
0	0	20	-20	-	-
1	15	30	-15	15	10
2	30	36	-6	15	6
3	45	40	5	15	4
4	60	46	14	15	6
5	75	56	19	15	10
6	90	71	19	15	15
7	105	92	13	15	21

Profit is highest (₹19) at Q = 5 and Q = 6: the 6th unit adds exactly as much to revenue as to cost (MR = MC = ₹15), and the 7th would cost ₹21 > ₹15. By the MR = MC rule with MC rising, the equilibrium output is 6. For units 1 to 5, MC is below MR, so each of them adds to profit.

Short-run condition (shut-down): the firm produces only if price ≥ minimum AVC; otherwise it loses more by producing than by shutting down (when it loses only its fixed cost). Here minimum AVC is about ₹6.5, so the firm produces at any price at or above that.

Worked example

At an output where MR = ₹15 and MC = ₹10 (rising), should the firm produce more or less?

Try it first, then show the solutionSolution

1. The next unit adds ₹15 to revenue and about ₹10 to cost
2. Profit rises by producing more until MC rises to ₹15

Answer: Produce more until MC = MR = ₹15.

Supply, supply curve of a firm and market supply

NCERT section 4.4 to 4.6

Supply is the quantity a firm is willing and able to sell at a given price during a period.

Law of supply: other things remaining the same, quantity supplied rises with price (the supply curve slopes upward). Reason: a higher price covers the higher MC of extra output, and makes production more profitable.

Firm's short-run supply curve: since a price-taking firm produces where P = MC (on the rising part of MC), and only if P ≥ minimum AVC, its short-run supply curve is the rising portion of the MC curve from the minimum point of AVC upwards. Below minimum AVC (the shut-down point) it supplies zero.

Market supply is the horizontal sum of the supplies of all firms at each price:

Price (₹)	Firm A	Firm B	Firm C	Market supply
10	0	10	5	15
12	20	25	15	60
14	40	40	25	105
16	60	55	35	150

Worked example

Suppose a firm's minimum AVC is ₹12. What does it supply at a price of ₹10 in the short run, and why?

Try it first, then show the solutionSolution

1. At ₹10 the price does not cover even AVC
2. Producing would add to losses beyond the fixed cost
3. It shuts down

Answer: Zero: price below minimum AVC is below the shut-down point.

Determinants of supply; movement along vs shift of the supply curve

NCERT section 4.5 and 4.6

Determinants of a firm's supply (other than own price):

• Technology: better technology lowers MC: supply increases (shifts right).
• Prices of inputs: a rise in wages or raw material prices raises MC: supply decreases (shifts left).
• Unit tax on output: raises MC: supply decreases. A subsidy increases supply.
• Prices of other goods the firm could produce: if wheat becomes more profitable, a farmer supplies less rice.
• Goals of the firm, expectations of future prices.

Market supply also depends on the number of firms (more firms: more supply).

Movement along the supply curve (expansion or contraction): change in quantity supplied due to a change in the good's own price.
Shift of the supply curve: change in supply at every price due to a change in any other determinant. Increase: rightward; decrease: leftward.

Worked example

Show the effect on the supply of shirts of (a) a rise in the price of shirts; (b) a rise in the price of cotton; (c) a new faster sewing machine; (d) a ₹20 tax per shirt.

Try it first, then show the solutionSolution

1. (a) Own price: movement up along the curve (expansion)
2. (b) Input cost up: leftward shift
3. (c) Better technology: rightward shift
4. (d) Tax raises MC: leftward shift

Answer: (a) Expansion along the curve; (b) and (d) decrease (left shift); (c) increase (right shift).

Price elasticity of supply (percentage method)

NCERT section 4.7

Price elasticity of supply (eS) measures the responsiveness of quantity supplied to a change in price:

$e_S=\frac{\%\text{change in quantity supplied}}{\%\text{change in price}}=\frac{\Delta Q}{\Delta P}\times \frac{P}{Q}$

It is positive (price and quantity supplied move together).

Value	Name
eS = 0	Perfectly inelastic (vertical supply curve)
eS < 1	Inelastic
eS = 1	Unitary elastic (any straight-line supply curve through the origin)
eS > 1	Elastic
eS = ∞	Perfectly elastic (horizontal)

On a straight-line supply curve: if it meets the price axis (positive intercept), eS > 1; if it passes through the origin, eS = 1; if it meets the quantity axis, eS < 1.

Factors: time period (supply is more elastic in the long run), nature of the good (perishable goods are less elastic in the short run), ease of increasing production, cost conditions, spare capacity.

Worked example

Suppose the price of tomatoes rises from ₹20 to ₹25 per kg and the quantity supplied rises from 400 to 600 kg. Find eS.

Try it first, then show the solutionSolution

1. % change in Q = (600 − 400) ÷ 400 × 100 = 50%
2. % change in P = (25 − 20) ÷ 20 × 100 = 25%
3. eS = 50 ÷ 25 = 2

Answer: eS = 2 (elastic): suppliers respond strongly to the higher price.

The Theory of the Firm under Perfect Competition in real life

Each concept, met in an everyday situation. Read the situation, answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Topics in this chapter

• Revenue and Producer's Equilibrium
• Supply and Price Elasticity of Supply

The Theory of the Firm under Perfect Competition: key facts

Total revenue

TR = P \times Q = \sum MR

Under perfect competition, a straight line from the origin.

Average revenue

AR = \frac{TR}{Q} = P

AR curve = demand curve facing the firm.

Marginal revenue

MR = \frac{\Delta TR}{\Delta Q} = TR_n - TR_{n-1}

Under perfect competition MR = AR = P.

Producer's equilibrium

MR = MC\ \text{and MC rising};\ \text{under PC: } P = MC

Also price ≥ minimum AVC in the short run.

Profit

\pi = TR - TC

Maximum at the equilibrium output.

Short-run supply curve

Rising part of MC above minimum AVC

Zero supply below the shut-down point.

Price elasticity of supply

e_S = \frac{\%\Delta Q_s}{\%\Delta P} = \frac{\Delta Q}{\Delta P}\times\frac{P}{Q}

Positive; percentage method only in the syllabus.

How the school exam asks The Theory of the Firm under Perfect Competition

The question patterns to expect, and the method that works for each.

Tricks to remember The Theory of the Firm under Perfect Competition

Short memory aids. Say each one aloud once, then use it on a question the same day.

• PC revenue

  "Price = AR = MR, flat as a table."

  Use it when: Revenue under perfect competition.

• Equilibrium

  "MR meets MC, MC climbing."

  Use it when: Producer's equilibrium.

• Supply curve

  "MC above the AVC valley."

  Use it when: Firm's short-run supply curve.

• Determinants of supply: "TIPTON"

  Technology, Input prices, Prices of other goods, Taxes, Objectives, Number of firms.

  Use it when: Shifts of supply.

The Theory of the Firm under Perfect Competition: exam-level solved questions

Ordered from exam level to HOTS. Cover the solution, write your own, then compare step by step.

Case-study practice (Section E style)

Read the situation, then answer every part. In a school exam set on the board pattern this is a 4-mark question split into 1 + 1 + 2 marks.

Where the marks are

How a typical answer is split into step marks. Show every step: a right final answer alone rarely earns full marks.

Where students lose marks in The Theory of the Firm under Perfect Competition

The slips examiners see most often, and what to write instead.

• ✗Mistake: Stopping at MR = MC where MC is falling

  Students take the first point where MR = MC.

  ✓Do this: Check that MC is rising at that output; the first crossing with falling MC is a minimum-profit point.

  Usually costs: 1-2 marks.

• ✗Mistake: Drawing the firm's supply curve as the whole MC curve

  Forgetting the shut-down point.

  ✓Do this: Only the rising part of MC from minimum AVC upward is the supply curve.

  Usually costs: 1 mark.

• ✗Mistake: Giving eS a negative sign

  Copying the habit from demand elasticity.

  ✓Do this: Price and quantity supplied move together, so eS is positive.

  Usually costs: ½ mark.

• ✗Mistake: Treating a change in input prices as a movement along supply

  Any change seems to affect quantity.

  ✓Do this: Only the good's own price causes movement; input prices shift the curve.

  Usually costs: 1 mark.

• ✗Mistake: Saying a firm should shut down whenever it makes a loss

  Confusing short run and long run.

  ✓Do this: In the short run, continue if price ≥ AVC (TR ≥ TVC): the loss is smaller than the fixed cost.

  Usually costs: 1-2 marks.

NCERT exercise guide: The Theory of the Firm under Perfect Competition

What each exercise in the NCERT chapter tests, how to approach it, and a question of the same kind solved step by step. Questions here are written in our own words.

Practice questions on The Theory of the Firm under Perfect Competition

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

1. Q1 · 1 mark · MCQExam level

   The demand curve facing a firm under perfect competition is:
   (a) downward sloping
   (b) perfectly elastic
   (c) perfectly inelastic
   (d) upward sloping

   Hint

   Price taker.

   Answer

   (b) perfectly elastic

2. Q2 · 1 mark · MCQExam level

   A straight-line supply curve passing through the origin has elasticity:
   (a) 0
   (b) less than 1
   (c) 1
   (d) more than 1

   Hint

   Proportional changes.

   Answer

   (c) 1

3. Q3 · 1 mark · Very short answerExam level

   Define marginal revenue.

   Hint

   One more unit.

   Answer

   The change in total revenue from selling one more unit.

4. Q4 · 3 marks · Short answerExam level

   Explain any three features of perfect competition and their implications.

   Hint

   Many firms, homogeneous, free entry.

   Answer

   Many firms: each is a price taker. Homogeneous product: no firm can charge more. Free entry and exit: firms earn only normal profit in the long run (also perfect knowledge: a single price prevails).

5. Q5 · 3 marks · Short answerHarder exam level

   Find TR, AR and MR: price ₹10 constant; output 1 to 5.

   Hint

   Constant price.

   Answer

   TR: 10, 20, 30, 40, 50; AR = 10 at all outputs; MR = 10 at all outputs.

6. Q6 · 3 marks · Short answerHarder exam level

   Given MR = ₹20 and MC at outputs 1-6 as ₹24, 18, 16, 20, 25, 30, find the equilibrium output and explain why not output 1.

   Hint

   MC rising at MR = MC.

   Answer

   MR = MC = 20 at output 4, with MC rising (25 next): equilibrium at 4. At output 1, MC (24) > MR (20), but MC then falls: producing more adds profit; MC is not rising there.

7. Q7 · 3 marks · Short answerHarder exam level

   The price of a good falls from ₹40 to ₹30 and quantity supplied falls from 500 to 400 units. Find eS.

   Hint

   % changes from original.

   Answer

   % ΔQ = −20%; % ΔP = −25%; eS = 0.8 (inelastic).

8. Q8 · 3 marks · Short answerHarder exam level

   Market supply: at prices ₹10, 12, 14, firm X supplies 5, 10, 15 and firm Y supplies 0, 6, 12. Find market supply.

   Hint

   Add horizontally.

   Answer

   5, 16, 27.

9. Q9 · 4 marks · Long answerHarder exam level

   Why is the short-run supply curve of a competitive firm the rising part of its MC curve above minimum AVC?

   Hint

   P = MC and shut-down.

   Answer

   A price-taking firm produces where P = MC with MC rising, so at each price the quantity supplied is read off the MC curve. But if price is below minimum AVC, producing adds to losses beyond the fixed cost, so the firm shuts down. Hence supply follows the rising MC curve only from minimum AVC upward; below it supply is zero.

10. Q10 · 3 marks · Short answerHarder exam level

    Distinguish between a movement along a supply curve and a shift of the supply curve with one cause each.

    Hint

    Own price vs other factors.

    Answer

    Movement: change in quantity supplied due to own price (expansion or contraction). Shift: change in supply at every price due to other factors, e.g. a rise in input prices (left) or better technology (right).

11. Q11 · 3 marks · Short answerHarder exam level

    Explain three factors that affect the price elasticity of supply.

    Hint

    Time, perishability, capacity.

    Answer

    (1) Time: supply is more elastic in the long run as firms can expand capacity. (2) Nature of the good: perishable goods are less elastic in the short run. (3) Spare capacity and ease of raising output: more spare capacity, more elastic supply.

12. Q12 · 4 marks · Long answerHOTS / competency

    Suppose the government imposes a tax of ₹5 per unit on a good produced by competitive firms. Explain the effect on a firm's MC, its supply curve and market supply.

    Hint

    Unit tax as a cost.

    Answer

    A unit tax adds ₹5 to the cost of each unit, shifting MC (and AVC) up by ₹5. Since the supply curve is the rising part of MC above minimum AVC, each firm's supply curve shifts up (left) by ₹5: at each price it supplies less. Market supply, the horizontal sum, also shifts left, which will raise the market price.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1. 1.Under perfect competition, AR equals?Show answer

   MR and price.

2. 2.What is TR when MR is zero (falling AR)?Show answer

   Maximum.

3. 3.State the two conditions of producer's equilibrium.Show answer

   MR = MC and MC rising.

4. 4.What is the shut-down point?Show answer

   The minimum point of AVC.

5. 5.Is elasticity of supply positive or negative?Show answer

   Positive.

6. 6.Effect of better technology on supply?Show answer

   Supply increases (rightward shift).

7. 7.How is market supply derived?Show answer

   Horizontal sum of firms' supplies at each price.

Quick revision checklist

The night before the exam: can you do each of these without looking?

• ☐Can you list four features of perfect competition?
• ☐Can you show AR = MR = P with a schedule?
• ☐Can you find TR maximum where MR = 0 for a falling AR?
• ☐Can you find equilibrium output from MR and MC with MC rising?
• ☐Can you explain the shut-down point?
• ☐Can you derive the firm's supply curve from MC?
• ☐Can you add individual supplies to get market supply?
• ☐Can you separate movements along and shifts of supply?
• ☐Can you compute eS and say whether supply is elastic?

The Theory of the Firm under Perfect Competition: frequently asked questions