Perfect Competition and determination of Price and Output under it

 

It is the market structure where there is large number of buyer and seller with homogeneous product selling at uniform price and characterized by complete absence of rivalry among the individual firms. In this competition, the price of the product is determined by industry with the forces of demand and supply.

Characteristics of Perfect Competition:

a.      There is a large number of buyers and sellers.

b.     There is homogeneous product.

c.      New firm is free to entry and exit.

d.     There is no government intervention.

e.      There is perfect mobility of the factors.

f.       Consumer has the complete knowledge about the market.

g.     There is profit maximization.

Determination of Price and Output under Perfect Competition

Under the perfect competition market, there are large number of buyers and sellers producing identical products. As such an individual firm becomes only the price taker where the price is determined by the industry on the basis of the market demand and market supply is known as equilibrium price and equilibrium quantity.

1.     Short-Run Equilibrium of a Firm

Short-run refers to the time period in which time is so short that a firm cannot change the fixed factors like plant and machinery. As the firm cannot change its production process and there may be abnormal profit or normal profit or even loss depending on the firm’s revenue and cost conditions. The firms that are more efficient may earn abnormal profit by reducing their average cost and inefficient firms having higher average cost may have the loss or some may just earn normal profit.

The profit and loss depend on the nature of AC and AR which can be shown in the following way:

a.      It AR=AC, the firm receives normal profit.

b.     If AR>AC, the firm receives excess profit.

c.      It AR<AC, the firm bears loss.

Conditions for Equilibrium:

The following condition must be fulfilled in order to attain the equilibrium in the perfectly competitive market:

a.      Market supply should be equal to market demand.

b.     MC=MR

c.      MC must intersect MR from below.

 

2.     Long-Run Equilibrium

In the long run, the firm can make choice for entry and exit from the industry depending on the profit situation. If profits are high, the new firms enter the industry. If the firms are in loss in the long-run, they exit from the industry. In this way, both abnormal profit and loss situations are ruled out in the long run and the firm will earn just the normal profit.

Conditions of Equilibrium:

a.      Demand must be equal to supply.

b.     LMC=MR

c.      LMC must intersect MR from below.