Price Determination under Perfect Competition
Under perfect competition, price is determined by industry demand and supply. Individual firm only accepts this price.
1. Industry vs Firm
- Industry – all firms producing homogeneous product.
- Firm – single producer.
Industry demand and supply determine equilibrium price (P₀). Firm takes P₀ as given.
Key Relation
In perfect competition, for an individual firm: AR = MR = Price (P).
2. Short-run Price Determination
(a) Industry Equilibrium
- Plot market demand curve (DD) and market supply curve (SS).
- Intersection gives equilibrium price P₀ and quantity Q₀.
(b) Firm’s Equilibrium in Short Run
- Firm faces horizontal demand curve at price P₀ (since it can sell any quantity at that price).
- Firm chooses output where MC = MR and MC is rising.
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Possible outcomes in short run:
- Abnormal (super-normal) profit
- Normal profit
- Loss (sub-normal profit)
3. Long-run Price Determination
In long run, firms can enter or leave the industry.
Conditions for long-run equilibrium:
- P = MC (profit maximisation)
- P = minimum LAC (only normal profit)
Entry and exit of firms ensure only normal profit in long run.
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4. Short-run Profits and Losses – Illustration
| Output (Q) | Price (P) | Total Cost (TC) | Total Revenue (TR) = P×Q | Profit (TR − TC) |
|---|---|---|---|---|
| 0 | 10 | 20 | 0 | -20 |
| 1 | 10 | 25 | 10 | -15 |
| 2 | 10 | 30 | 20 | -10 |
| 3 | 10 | 32 | 30 | -2 |
| 4 | 10 | 38 | 40 | 2 |
| 5 | 10 | 50 | 50 | 0 |
Interpretation
At output 4, firm earns super-normal profit (2). At output 5, profit is normal (zero economic profit).
5. Quick Revision Points
- Industry demand and supply determine equilibrium price.
- Firm is price taker, faces horizontal demand (AR = MR = P).
- Equilibrium output where MC = MR, MC rising.
- Long run: only normal profits, price = minimum LAC.
6. Quiz Time 🎯
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