The firms in a perfect competition environment are said to be price takers. The demand curve of a perfectly competitive firm is perfectly elastic at the going market price like diagram 2 shows. This means that the seller can sell all their products at the market price without affecting this price.
The theory of perfect competition also is based on the assumption that firms seek to maximize profits. Economic profits indicate whether or not resources are being directed to their best use. They represent the amount by which revenue exceed total opportunity costs . For example, Santiago has a motorcycle business. Santiago has placed $60.000 of his money into his own business. However, he could earn $2000 per month working as a motorcycle seller at another motorcycle shop. Moreover, Santiago's capital investment in his own business might earn $500 monthly elsewhere. The sum of this two ($2500) is an implicit cost of doing the business. The explicit or accounting costs involve are Santiago's rent payments on the building, inventory costs, business taxes and wage payments to mechanics and sellers. All of these add up to $37000 per month. Santiago's total monthly opportunity cost for operating his business is the sum of implicit cost ($2500) and explicit costs ($37000) = $39500. Supposing that Santiago's business has monthly sale of $40000, Santiago's accounting profit would be $3000 per month. Santiago's economic profit is only of $500 because the total opportunity costs are $39500. If in this case the accounting profit was below $2500, Santiago would not have entered the business because he would not earn a normal profit. .
In order to maximize profits marginal cost (MC) must equal marginal revenue (MR). A firm will always produce a t the point when P=MC. The diagram below shows the short term equilibrium of a firm and the market in a perfect competitive market. .
The Representative firm The market .