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Perfect Competition

- A perfectly competitive firm decides on an output quantity to maximize profits by setting marginal revenue equal to marginal cost (MR=MC) - In the short run, firms may earn super normal, normal, or losses depending on if average revenue is above, equal to, or below average cost - In the long run, firms will exit if losing money and new firms will enter if profits are being made, adjusting the market until all firms earn normal profits

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63 views

Perfect Competition

- A perfectly competitive firm decides on an output quantity to maximize profits by setting marginal revenue equal to marginal cost (MR=MC) - In the short run, firms may earn super normal, normal, or losses depending on if average revenue is above, equal to, or below average cost - In the long run, firms will exit if losing money and new firms will enter if profits are being made, adjusting the market until all firms earn normal profits

Uploaded by

S1626
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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PERFECT COMPETITION

SYBA
PROFIT IN PC IN THE SHORT-RUN

- A perfectly competitive firm has to decide what quantity to produce


- Profit: π=TR−TC
- Since firm is a price-taker, it can only decide the quantity to be sold
If the firm sells a higher quantity of output, then total revenue will increase (TR-
TC approach)
CONDITIONS FOR EQUILIBRIUM

- MR-MC approach (marginal variables used)


1. MR = MC (Necessary condition)
2. MC curve should cut the MR curve from below
(Sufficient condition)
SHORT- RUN EQUILIBRIUM OF A FIRM

 In the short-run there can be two cost conditions


1. Identical cost conditions: Means all firms are facing same cost-conditions, that
is, their average and marginal cost curves are of the same level and shapes. This
would be so if the entrepreneurs of all firms are of equal efficiency and also the
other factors of production used by them are perfectly homogeneous and are
avail­able to all of them at the same prices
2. Differentiated cost conditions: all firms face different costs. Thus, cost curves of
all firms will be different
SUPER NORMAL PROFIT
(IDENTICAL COST CONDITIONS)

• Firm will make super normal profit, if at equilibrium, AR > AC


• Equilibrium at e where MR=MC
• Profit = TR – TC
• TR = AR x output
= (eXe) x (OXe) = OPeXe
• TC = AC x Output
= (BXe) X (OXe) = OABXe
• Profit = TR – TC
= OPeXe – OABXe
= APeB
NORMAL PROFIT

• At equilibrium, AR = AC
• Firm is at equilibrium at point A where
MR=MC
• TR= AQ x OQ = OPAQ
• TC = AQ x OQ = OPAQ
• Since, TR = TC we have normal profit
LOSS

 e is the point of equilibrium


 Loss = TC – TR
 TR = (eXe) x (OXe) = OPeXe
 TC = (CXe) x (OXe) = OFCXe
 Loss = OFCXe – OPeXe
 AR < AC, thus firm is making losses
 If the firm is able to cover the AVC, it
continues its operations
SHUT-DOWN POINT

• AR < AVC
• The firm can minimize its losses up to fixed
costs only by not producing
• E is point of equilibrium
• TR = EX * OX = OPEX
• TC = BX * OX = OABX
• Loss = OABX – OPEX
= PABE
= Shaded area + PDCE
= TFC + part of TVC
LONG-RUN EQUILIBRIUM OF FIRMS UNDER
IDENTICAL COST CONDITIONS
 All factors of production are variable in the long run
 Firms enter and exit the industry
 When some firms are earning super-normal profit in the long-run, i.e. AR > AC,
new firms are lured to enter the industry
 Thus, output increases and prices fall
 When firms face losses, AR < AC, some firms exit the industry
 Output reduces and prices rise
 Normal profits
LONG RUN EQUILIBRIUM OF FIRMS UNDER
DIFFERENTIAL COST CONDITIONS

 Intra-marginal firms: Managed and controlled by the most efficient entrepreneurs


so that their cost of production is low. They earn super-normal profits in the long
run
 Marginal firms: Managed and controlled by less efficient entrepreneurs and they
manage to get normal profits
LMC

LAC

D=LAR=LMR

Equilibrium position of Intra-marginal and marginal firms


DIFFERENCE BETWEEN A FIRM AND
INDUSTRY

 A firm is a commercial enterprise, a company that buys and sells products and/or
services with the aim of making a profit.

 An industry consists of several different firms selling similar products


SHORT- RUN EQUILIBRIUM OF THE
INDUSTRY
 Industry is in equilibrium at the price at which the quantity demanded is equal to
the quantity supplied
 This is a short-run equilibrium because at this price, firms are making either excess
profits or losses
LONG-RUN EQUILIBRIUM OF THE
INDUSTRY
 Firms that make losses and cannot readjust their plant will close down
 Those that make excess profits will expand their capacity
 excess profits will attract new firms
 Entry, exit and readjustment of the remaining firms in the industry will lead to a
long-run equilibrium in which firms will just be earning normal profits

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