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PERFECT COMPETITIONDEFINITION “A Perfect Competition market may be defined as a large number of buyers and sellers all engaged in the purchase and sale of identically similar commodities, who are in close contact with one another and who buy and sell freely among themselves.” (Boulding)So it is a market structure characterized by the existence of large number of buyers and sellers and each seller is selling identical products which are close substitutes. FEATURES OR CHARACTERISTICSThe following characteristics are essential for the existence of Perfect Competition:1.?Large Number of Buyers and Sellers:The first condition is that the number of buyers and sellers must be so large that none of them individually is in a position to influence the price and output of the industry as a whole. 2.?Homogeneity of the Product:Each firm should produce and sell a homogeneous product so that no buyer has any preference for the product of any individual seller over others. The homogeneity of products presupposed uniform price for the products in the market.3.?Free Entry and Exit of Firms:The firm should be free to enter or leave the firm. If there is hope of profit the firm will enter in business and if there is possibility of loss, the firm will leave the business.4.?Perfect Knowledge of the Market:Buyers and sellers must possess complete knowledge about the prices at which goods are being bought and sold and of the prices at which others are prepared to buy and sell. This will help in having uniformity in prices.5. Perfect Mobility of the Factors of Production and Goods:There should be perfect mobility of goods and factors between industries. Goods should be free to move to those places where they can fetch the highest price.6.?Absence of Transport Cost:There must be absence of transport cost. If transport costs exist, then it will be difficult for sellers to sell the products at the same price.PRICE AND OUTPUT DETERMINATIONOREQUILIBRIUM OF FIRM AND INDUSTRY The price and output determination or equilibrium of the firm and industry is studied under two different time periods such as short run and long run.A. Short Run Equilibrium of the FirmSince a firm is a price taken under perfect competition, its average revenue is always equal to its marginal revenue (AR=MR). The AR curve and the MR curve of the firm is given below:D1FIG. 2: FIRMFIG.1.MARKET OR INDUSTRYPRICE/ REVENUEDSPriceAR1=MR1P1P1D0AR=MRPE1AR0=MR0P0PEP0E0D1DSOOD0OUTPUTDEMAND & SUPPLYIn the above diagram, fig 1 shows the industry or market equilibrium wherein the price of the product is determined by the demand and supply. The demand curve is downward sloping and the supply curve is upward slopping. The industry is in equilibrium at point E in the first diagram and the equilibrium price in the market is OP. The firm is able to accept OP price and can produce and sell any number of quantity of the product at the existing market price. Hence, its AR is equal to its MR curve which shown by AR-MR curve in the diagram. The industry equilibrium changes either by changes in demand or supply. When the demand increases, the demand curve shifts to the right which increases the equilibrium price to OP1 which will be accepted y by the firms. The firms AR =MR curve shifts up due to the change in price in the industry which is shown by AR1=MR1 curve in the diagram. Similarly, when the price in the industry decreases, the firms AR=MR curve also slides down to AR0=MR0 as shown in the diagram 2.EQUILIBRIUM SITUATIONS DURING SHORT RUNDuring the short run, a firm under perfect competition may confront either one of the following situations:Supernormal Profit or Abnormal Profit (AR>AC)Normal Profit (AR=AC)Loss (AR<AC)1. Supernormal Profit or Abnormal Profit (AR>AC)A firm can make supernormal profit when its AR is more that its AC of production. This can be shown with the help of the following diagram:YEPFCMCSACAR=MROUTPUTPRICE/REVENUE/ COSTXQOIn the above diagram, the quantity of output is measured along the X axis and the price, revenue and cost is measured along the Y axis. The AR=MR is the marginal and average revenue curve which is horizontal to output axis. SAC is the short run average cost curve and MC is the marginal cost curve of the firm. The firm is in equilibrium at point E where MC=MR and MC is rising. At the equilibrium point, the firm produces an output of OQ quantity and sells it at a price of OP. At the equilibrium output, the average cost (AC) is QC and the AR is QE. Since AR> AC, the firm is making per unit profit of EC. At the equilibrium point, the total cost of production (TC) is equal to the area OQCF and the total revenue (TR) is equal to the area OQEP. The difference between OQEP and OQCF is equal to the area FCEP which is the total supernormal profit earned by the firm at the equilibrium output of OQ.2. NORMAL PROFIT (AR=AC)The firm is making normal profit when its AR is equal to its AC as it is able to recover the implicit cost along with the AC of production. The normal profit situation is given in the following diagram:YMCPRICE/ REVENUE/ COSTSACEAR=MRPXOUTPUTQOIn the above diagram, the firm is in equilibrium at point E where MC=MR and MC is rising. The firm produces an equilibrium output of OQ and sells it at a price of OP. At the point of equilibrium, the AR is QE and the AC also is QE. Since AR=AC, the firm is making normal profit at the point of equilibrium.3. LOSS (AR<AC)The firm is incurring loss when its AR is less that its AC of production. The loss is illustrated with the help of the following diagram:MCYSACCPRICE/ REVENUE/ COSTHPAR=MREOQXOUTPUTIn the above diagram, the firm is in equilibrium at point E where MC=MR and MC is rising. At the point of equilibrium, the firm is producing an equilibrium output of OQ. The AC is QC and the AR is QE. Since AR is less than AC, the firm is making loss. The total loss is equal to the area PECH.LONG RUN EQUILIBRIUMIn the long run new firms can enter the industry or existing firms can leave the industry. New firms enter when the existing firms are making huge profit and the firms leave the market when they incur loss. When the existing firms enjoy supernormal profit, new firms enter the market. When new firms enter the market, the supply of the product increases in the market which will reduce the prices of the product. When prices decrease, the profit gradually vanishes and it becomes loss. When loss is incurred, some firms will leave the market, which in turn increases the prices and loss gradually get eliminated. Thus in the long run the firms can enjoy only normal profit because when the profit is normal, new firms will not enter the market or existing firms may not leave the market. So in the long run, the industry as well as the firms will be in equilibrium. This is shown with the help of the following diagram:MCyPRICE/ REVENUE & COSTQOUTPUTAR =MREOPLACXIn the above diagram, LAC is the long run average cost curve and MC is the long run marginal cost curve. The firm is in equilibrium at point E where MC=MR and MC rising. The equilibrium output is OQ and the selling price is OP. At the point of equilibrium AR=MR=Minimum LAC=MC=Price. ……………………………………. ................
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