When we talk about perfect competition we mean a market structure that leave firms in a unique brand of competition. In fact a firm does not actually compete under perfect competition, it reacts to the market conditions, taking price and other market factors as beyond its control. A market is a perfect competition if it meets four basic criteria. The product of all sellers must be identical. All participants in the market, buyers, sellers, must be small relative to the entire market. As a result there should be many firms and buyers in the market. There are no barriers to entry or exit to the market. Firms can enter and leave as they wish. Fourthly market participants have perfect knowledge of and access to technology and prices.
When a firm fulfils these criteria it can then be categorised as a price taker. Those firms who are unconcerned about there competitors, because there is nothing they can do to influence there own behaviour, that of their rivals or the final market outcome. As shown in Fig 1 the price takers demand curve is perfectly horizontal. At the market price Pm the firm can sell as much as it wants of a specific product. The firm has no incentive to lower prices as it can sell all it wants at the market price. Furthermore the firm as no ability to raise price as potential customers would buy the same product elsewhere. The firm there for has no alternative but to sell at Pm , at which it face an infinite price elasticity of demand.
The Essay on How Firm Behave Under Perfect Competition In The Short And Long Run
... output it must sell at the market price, which is referred ... product of other firms, the firm views itself as having no influence on the market price. In perfect competition, if a firm wants to sell any of its ...
The question asks what will happen in the long run when price exceeds short run average cost. We must first determine the objective of the firm, – profit maximisation. Any typical firm will set production where marginal revenue equals marginal cost. A perfectly competitive firm however, taking into account the relationship between marginal revenue and price will achieve profit maximisation by setting output where marginal cost equals price. The profit maximising firm in perfect competition will produce where P=MC We can see the firms production condition by showing marginal cost, average cost and variable costs curves on the firms demand curve. As depicted in Figure 2. The figure uses short run cost curves as production decisions occur in the short term.
It is important to realise that firms adjust differently in the short and long term. For example, in the short term when price exceeds average cost of producing at the profit maximising level then a firm would make an economic profit (Supernormal).
When P becomes equal to minimum average costs the firm breaks even and makes normal profit. Should P fall below minimum average costs, obviously the firm would now incur economic loss. Firms in the long run will either enter or exit from the market depending on whether profit or loss is made or they will change their size. In other words expand their scale of operation. Should economic losses occur then the firm would leave the market or adjust capital to mitigate the low returns and visa versa in profit making circumstances.
When price exceeds average cost, we know already that it brings about positive profit. These are also known as supernormal profits. However these profits are dependent on market price as it fluctuates as illustrated in Fig 3. The existence of perfect competition where these profits occur is an attractive package because there is perfect knowledge. New firms want a share of the market, begin producing and the market curve will shift outwards. This pattern will continue to occur where output and profit are smaller than when entry occurred until no more incentive exists. The firm will then only making normal returns (breaking even).
The Essay on Normal Profit Firms Run Price
... can find the short run break even price and the short run shut down price by comparing the price with average variable total costs. Profit maximization occurs where ... therefore profits are declining. Profit - at the profit maximizing output average cost (which includes normal profit) is below average revenue and therefore the firm is making supernormal profits equal ...
The firm at this point will be producing at the minimum average cost, and thus cannot change output to enhance profits. There are no longer any incentives for entry or exit as profits are zero. From some perspectives this may seem as a stable condition. This is very dependent upon the ambition of the firm.
It is also necessary to consider the long run equilibrium situation and the remaining option where firms may want to increase capital. Long run equilibrium requires firms to have no reason for entry, exit, expand or contract within the market. The long run cost curve shows the firm may have a motivation to change capital or expand as seen in Fig 4. The figure superimposes short run cost curves over the long run average cost curve. The firm operates with the curves with subscript 1 at a market price of Pm where profit is zero. The firm subsequently invests more capital and moves to the curves subscripted 2, the firm makes supernormal economic profit again. The incentive to expand as a result of price originally exceeding average costs therefore exists. See Fig 4.
Long run equilibrium means that there are no opportunities for current firms to increase profit, no reason to exit the market, and gives investors no ambition to enter the market. The equilibrium position is reached the moment price (P) equals minimum long run average cost an output of Q1 in figure 5. Supply and demand establish the market price Pm . At that price the firm maximises profits at Q1 where short run marginal costs equals price (P) and both short and long run average costs are at there lowest values. We know that price is equal too average cost therefore profits are zero. Since the firm is at the minimum long run average costs, no shifts can be made to alter profits positively.
It seems this type of equilibrium follows a full circle. Once firms either enter the market supply shifts rightwards and when they exit a leftwards shift occurs, thus resulting in the relationship between average cost and price changing when the market develops. The process revolves again. An interesting and yet pertinent paradox to finish on is that the desire to make above normal profits results in a zero profit equilibrium in the competitive market. Firms will make a normal profit, but no more.
The Essay on Besting Market Failure With Perfect Competition
... marginal cost of producing a good or service, and the producer is unable to make a profit (“Perfect Competition;” “The Market Economy”). A firm ... the free-rider problem. Because the private firm in a perfectly competitive market sells for profit, it is not feasible for it to ... considered profitable to produce in either the short- or the long-run. The benefits of public goods or services cannot easily be ...
