What is a perfect Competition? How equilibrium of a firm is determined under perfect Competition in the short period and Long Period. (2017)
Perfect Competition:- Perfect Competition is that market where there are a large number of buyers and sellers of homogeneous products. It is impossible to distinguish between the units being sold by them. So the price of the commodity is determined by the industry. At the same determined price all firms will sell their products. equilibrium under perfect competition
According to Ferguson:- “Perfect Competition describes a market in which there is Complete absence of direct Competition among economic firms. The equilibrium under perfect competition can be seen where homogeneous products are available.
A Firm Can be in equilibrium throughout two period as following
- Short Run Equilibrium of the Firm
- Long Run Equilibrium of the Firm
DETERMINATION UNDER SHORT RUN EQUILIBRIUM OF THE FIRM
A Short Run is that period in which a firm can’t enhance its capacity of plant for the purpose of increasing supply. Neither existing firms will leave in a short period, nor new firms will enter into the market. So it will be difficult to change the existing structure of the firm in the short run. The equilibrium under perfect competition in short period can’tincrease supply by supplier.
IN THE Short run Equilibrium a firm may face three situations in the market industry.
- Super Normal Profit
- Normal Profit
- Minimum Loss
( 1 ) Super Normal Profit:- A firm is in equilibrium when its marginal Cost is equal to marginal revenue ( MC=MR ) and Marginal Cost Curve Cuts Marginal Revenue Curve from below. In the equilibrium under perfect competitio firm can earn super normal profit when revenue is more than cost. So in short run in equilibrium under perfect competition can expect super normal profit.
- A firm earns Supernormal profit, when average revenue is more than average Cost. ( AR>AC ).
However it can be understand with the following figure:-
- Output shown on X-axis and Revenue/Cost on Y-axis.
- At Equilibrium point E, MC = MR
- Equilibrium Output = OM
- Per unit Profit ( AR>AC ) = EM – AM = EA.
- Super Normal Profit = OM×EA = EABP, shades area.
Thus, the firm will be in equilibrium at point E and produce OM output. At this point it will be earning EABP for Super Normal profit.
( 2 ) Normal Profit:- A firm is in equilibrium when it earns normal profit. When it earns normal profit its average cost is equal to the average revenue. In the short run equilibrium under perfect competition a firm can earn revenue equal to cost. So equilibrium under perfect competition a firm can be in short run.
However it can be understand with the following figure:-
- A firm is in equilibrium at point E and OM is the equilibrium output.
- At point E, marginal cost and Marginal Revenue are equal.
- And the marginal cost curve cuts the marginal revenue curve from below.
- Firm earns normal profit at OM output because at this point its MC=MR=AR=AC.
- In other words average costs are equal to average Revenue.
( 3 ) Minimum Loss:- A firm in equilibrium may incur minimum loss when Average Cost is more than Average Revenue. In the short run period equilibrium under perfect competition may also face such situation when a firm earns revenue less to cost is called minimum loss.
- Even so, the firm discontinued its production in the short period. When the price ( AR ) is less than the average variable cost ( AVC ).
- It will bear the loss of fixed costs.
- Which loss of fixed costs is the minimum loss of the firm.
- As when in the long period, the price is more than or equal to the average variable costs (AVC )
- Then the firm will continue with its production.
Now we can understand with the help of the following figure.
- AC is the average Cost and AVC is the Average variable Cost.
- Price ( AR ) is determined by the industry.
- At this price, the firm is in equilibrium at point E.
- Where marginal cost equals to marginal revenue. Marginal Cost Cuts marginal Revenue from below.
- At point E, when the firm produces ON equilibrium output. Then its average cost is AN while its average revenue is EN.
- In other words, average cost is more than average revenue by AE per
As Such firm’s total loss is AE × PE ( ON ) = AEPB, the Shaded area. If price falls to OP1 Then its equilibrium output will be OM.
- At this low price, firms will be getting its average variable cost only and so will be incurring the loss of total fixed cost.
- It will constitute the minimum loss to the firm and it will continue its production even at OP1 price.
- In case price falls below OP1 then the firm will not be able to meet its average variable cost even.
- It will constitute more than minimum loss and to avoid it, the firm will prefer to shut down its production.
Conclusion:- In the short period, it leads to the following conclusion.
- If AR = AC, the firm earns normal profit.
- If AR > AC, The firm earns supernormal Profit.
- If AR < AC, The firm incurs Loss.
- If AR < AVC, the firms will stop production.
DETERMINATION OF LONG RUN EQUILIBRIUM OF THE FIRM
IN CASE of long run equilibrium, a firm will produce the commodity at minimum long-run average cost. Not only the firm’s long-run marginal cost and marginal revenue will be equal but minimum long-run average cost and average revenue will be equal. In the long run equilibrium under perfect competition can earn normal profit.
It represents to a long-run marginal cost that will be equal to the long-run average cost.
Note:- Marginal cost is equal to average cost at that point where average cost is minimum. Thus, in the long run a firm gets only normal profit. ( LAV = AR ).
We will understand with the help of the following figure.
- SAC is a short run average cost curve and LAC is long run average cost curve.
- SMC is a short run Marginal cost curve and LMC is a long run Marginal Cost Curve.
- AR = MR Curve refers to Average Revenue price and Marginal Revenue which are equal under perfect competition.
- Let assume, OP price is determined by industry.
- Firm is producing with the help of SAC1 plant and is earning supernormal profits, as indicated by ABNP shaded area.
- Then firms will increase their production and new firms will enter into industry. As a result , the supply of the product will increase in the industry.
- Due to an increase in supply, the price will fall to OP1. At OP1 price, the firm will be in long run equilibrium at point E & OM will be equilibrium output.
- It is so because at point E, marginal revenue, long run marginal cost, average revenue and long run average cost are all equal.
- Condition of long run equilibrium of each firm is
LMC = MR = AR = LAC
Conclusion:- In the long run any firm can earn normal profits. As we see that when any firm can earn supernormal profits, then new firms will enter into the industry to earn profits. Due to which supply will be increased in the market. In results of which price will decline then all existing firms will earn normal profits. So all firms in equilibrium under perfect competition may face short run and long run situation.
👉 NOTE – Essential Understandable reminder of short run and long run data.
In Short Run, Firms can earn
- Normal profits
- Super normal profits
- Minimum loss
In Long Run, Firms can earn
- Only Normal Profits
equilibrium under perfect competition can be raised under the situation of homogeneous products.
Essential Questions of Perfect Competition
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