PERFECT COMPETITION

INTRODUCTION:
The term market refers to the link between the buyers and the seller. The link can be established through a number of ways like through telephones, fax, e-mails, etc. It is not necessary for the buyer and the seller to meet directly in many cases. Markets are classified as product markets and factor markets. The product market is the market where goods and services are bought and sold. The product market is classified on the basis of the commodity sold i.e. whether they are homogenous or heterogeneous or on the basis of the number of buyers and sellers. Market is also classified on the basis of time and place. The broad classification of market is as follows: (1)- On the basis of place it is classified as local, national, and international. (2)- On the basis of time it is classified as very short period, short period, long period, and very long period. (3)-On the basis of nature of the product, number of sellers and degree of competition markets are classified into perfect competition and imperfect competition. Table. MEANING: Perfect competition is an ideal market structure which ensures rational utilization of resources. Perfect competition avoids exploitation of laborers and consumers. A perfectly competitive market exhibits the following features: FEATURES: (1)- There are large number of sellers. Each sellers sell a small fraction of the output. He cannot influence the price of the commodity by changing his supply. He has to accept the privailing price and sell as much as possible at the existing price. Hence a firm under perfect competition is said to be a price taker. (2)- There are large number of buyers. Each buyers buy a small fraction of output. Hence he cannot influence the price through his purchase. (3)- All the units of commodity produced and sold by the firms are homogeneous in

nature. Hence they are perfect substitute for each other. (4)- A single price prevails in the market. (5)-There is free entry and exits. A firm can enjoy the industry and any firm can leave the industry. There are no restrictions on entry and exit. (6)- There is no government intervention. Market mechanism is allowed to play its role in determination of equilibrium price and output. (7)- The transport cost is assumed to be nil. It is assumed that either all the firms are close to the market or equally far away from the market. Hence the transport cost is assumed to be nil. (8)- Factors of production are said to be perfectly mobile. This ensures equal factor cost for all the firms. (9)- Both the sellers and buyers have perfect knowledge about the market. If any seller tries ton sell at a higher price, the consumer will shift to the other seller. Similarly no seller would like to sell at a lower price as all the sellers know about the market price. DETERMINATION OF EQUILIBRIUM PRICE AND OUTPUT: The term equilibrium refers to the position of rest. A firm is said to be equilibrium when it has no tendency to change the level of output. This happens when the firm maximizes its profits. One of the aims of any business firm is to maximize its profits and is considered as rational. Profit is the difference between total revenue and the total cost. Total revenue is the revenue earned by sale of output. It is obtained by multiplying the price per unit by the quantity of put-put sold. Total cost consists of rent, wages, interest and normal profit. Normal profit refers to remuneration, the entrepreneur should get for management and coordination. It is the minimum income that should be earned by the entrepreneur to stay in the business. The difference between the total revenue and total cost refers to pure or economic profits. Economic profits are also known as super normal profits. A firm will be in equilibrium when it produces that level of output at which its profits are maximized. There are two approaches to explain this namely (1)-Total revenue- Total cost approach and (2)- Marginal revenue-Marginal cost approach. TOTAL REVENUE-TOTAL COST APPROACH. Under this approach the firm is said to be in equilibrium when the difference between total revenue and total cost is maximum. Under perfect competition there is a single price and all additional units are sold at the same price. The total revenue therefore will increase at the same rate. Equilibrium of the firm can be explained with the help of a diagram. TABLE. In the above table when the firm produces the first unit TC is more than TR. When more units are produced the firm starts earning profits. Profits start increasing. It

earns maximum profits when the 6th unit is produced. Hence the firm will be in equilibrium when it produces 6 units of the output. The above table can be translated in the form of the diagram given below. In the above diagram, TR curve is linear curve indicating that TR increases at a constant rate. The TC curve starts from point F on the Y axis indicating fixed cost. After this break even point, the firm starts earning profits. The difference between TR and TC is maximum when the firm produces OQ level of output. This is said to be the equilibrium level of output. After this point if the firm produces more, profit starts declining. At point B2, TR=TC and after this point total cost is equal to the total revenue. Hence a rational firm would like to produce OQ level of output and maximize its profits. MARGINAL REVENUE- MARGINAL COST APPROACH. An alternative namely MR-MC approach has been developed to determine equilibrium of the firm. The firm is said to be in equilibrium when MR=MC. This can be explained with the help of the following table and diagram.

In the above table when the firm produces the sixth unit, MR= MC. The firm is said to be equilibrium when it produces six units which is profit maximizing level of output. In the diagram AR and MR coincides with each other and is represented by horizontal strait line. The MC cuts the MR curve at two points E and E1. At E1 MC is cutting the MR from above. After this point MC lies below MR curve and is profitable for the firm to produce more. At point E MR is equal to MC c and the MC curve cuts the MR curve from below. As long as MR is greater than MC, it is profitable to increase production. Thus there are two conditions to be satisfied for the firm to attain equilibrium. (1)-MR=MC, (2)- MC curve cuts MR from below. The first one us a necessary condition but not sufficient one. The condition has to be satisfied for a firm to attain equilibrium and maximize the profit. SHORT RUN EQUILIBRIUM FIRM AND THE INDUSTRY. Under perfect competition the market price is determined by the forces of demand and supply. The equilibrium price is determined at the point where the demand and the supply curve intersects each other. The determined by the industry has to be accepted by the individual firm and it can sell as much output as it wants at that price. The firm will attain equilibrium at that point where MR=MC and MC curve cuts the MR curve from below. The individual firm may earn super normal profits or incur loss in the short run. This can be illustrated with the help of a diagram. In the diagram, the demand and supply curve of the industry intersects each other at point E. The equilibrium price is OP. This price accepted by the individual firm and it can sell as much output as possible at this price.

In the another diagram the individual firms short run marginal cost curve cuts the MR curve from below at point E. At this point MR=MC and MC curve cuts the MR curve from below. Therefore E is the equilibrium point. The firms total revenue is OQEP. The total cost incurred by the firm is OSRQ. Therefore the difference between the two i.e.PERS is super normal profit earned by the firm. In the short run the firm can incur loss also. It can be represented in the diagram. According to the diagram E is the point of equilibrium. AC curve lies above the AR curve indicating that average cost is more than average revenue. Here the total cost is OQRS. Total revenue us OQEP and the difference between two represents the loss incurred by the firm. Therefore loss is equal to PERS, the shaded portion in the diagram. In the short run under perfect competition business firms may incur loss or they may get super normal profits. If they earn super normal profits, more firms will be attracted to the industry. This is possible due to free entry. Due to the increase in the number of the firms , supply will increase will reduces the price in the long run super normal profit will become the normal profit. On the other hand if some firms incur loss, they will leave the industry. Supply will become less, price will rise and this will help the firm to wipe out the losses Hence in the long run all the firm will be equilibrium and hence the industry will also be in equilibrium. In short run the firm may be in equilibrium but the industry may not be in equilibrium. In short run under perfect competition the equilibrium price is determined by the industry according to demand and supply. This price has to be accepted by the individual as given and it has to adjust its supply accordingly. The equilibrium price will change whenever there is the change in demand and supply conditions. Hence the short run equilibrium is not a stable one. Depending upon the price fixed by the industry and the cost incurred by them the firm may get super normal profit, loss or it may face shut down condition. These four possibilities can be explained with the help of a diagram. According to the diagram the firm earns super normal profits. It is indicated by the shaded portion PERS. In another diagram the firm is in equilibrium at point E where MR= MC, MC curve cuts MR from above and AR=AC. Therefore the firm earns normal profit. In the next figure AC curve is above AR curve. Though the firm is incurring loss it will continue its production as long as it is able to recover the variable cost of production. Here the firm is able to recover the variable cost and a part of the fixed cost. The incurred by the firm is equal to PRES, the shaded portion in the diagram. Another figure shows that the firm is not able to recover even the variable cost. the price less then average variable cost. Hence the firm should stop production. No rational will produce after this point. When the price is less then the AVC is called the shutdown point. The above equilibrium price and output determination is based on the assumption that all the factors of production are homogeneous, and all that firms

face the same condition. Suppose all the factors same except the entrepreneur. The entrepreneur may vary in their efficiency. In such case the most efficient firm will get super normal profit, the efficient firm may get normal profits, the least efficient may incur loss or it may face the shut down point. Whether it is a homogeneous or a heterogeneous cost condition, some firms may incur loss or some may incur profits. Hence the entire industry will be in equilibrium only in the long run. LONG RUN EQUILIBRIUM FRIM AND INDUSTRY. Long run is the time period which enables the firm and industry to change the scale of production. All the factors are variable in long run. The industry will be in equilibrium when all the firms makes normal profits. When the firms earns normal profits there is no tendency on the part of the firms to enter or leave the industry. The long run equilibrium can be explained with the help of a diagram. In the figure given, the demand and the supply curves of the industry intersect each other at point E, OP is equilibrium price and OQ is the equilibrium quantity demanded and supplied. In the next figure, the two conditions for equilibrium is satisfied at point E, The firm accepts the price given by the industry as given and sells the OQ amount of output. At point E, AR=AC, MR=MC and the MC curve cuts the MR curve from below. the firm earns only normal profits, the industry is said to be equilibrium. Of all market structures, perfect competition is said to be the idol market structure. It ensures optimum utilization of resources. The output produced is more, the price charged is nominal and it avoids exploitation of labor. In reality however it does not exits. To some extent it can be seen in agriculture. Though it is not found in reality, in economic theory, perfect competition occupies an important place.