Equilibrium of the firm under:

Perfect Competition

According to Boulding “Perfectly

competitive market is a situation where
large number of buyers and sellers are
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.”
Characteristics of Perfect competition
1. Large Number of Buyers and Sellers
2. Existence of Homogeneous Product
3. Free Entry and Exit of Firms
4. Buyers and Sellers have full Knowledge of
market
5. Mobility of Factors of Production
6. Non-Existence of Transport Costs
7. Non-existence of Government Restrictions
8. Non-existence of Price Control
 Equilibrium of the firm
under perfect competition (Short run)

The Equilibrium of the firm can be discussed in

terms of :

• Total cost and Total Revenue (TC/TR)

• Marginal Cost and Marginal Revenue (MC/MR)

 Short-Run Cost curves
Total Cost = Total Fixed Cost + Total Variable Cost
• Total Fixed Cost (TFC) is graphically denoted by a straight line
parallel to X-axis showing output.
Total Fixed Cost Curve Total variable cost curve

• The Total Variable Cost Curve as shown in Figure has broadly

an inverse 'S' shape. This reflects the law of variable
proportions.
.

Total Cost Curve TC, TVC and TFC

 Equilibrium of a firm
under Perfect Competition through TC & TR
 Equilibrium of a firm under perfect competition through MC & MR

• To maximize profits, a firm should produce

and sell up to the point at which the MR=MC
• Beyond the point of equality of marginal cost
and marginal revenue the firm will experience
losses
• Thus, the main condition of firm's equilibrium
is that the firm should stop at the point of
equality of marginal cost and marginal
revenue.
Equilibrium of a firm under perfect competition
through MC & MR
• The marginal cost curve is given as
a dotted line.
• Point ‘A’ shows the equality of
marginal cost and marginal
revenue.
• ‘OQ’ is the maximum quantity
which the firm can produce as this
is the profit-maximising quantity.
• Output beyond this, say at 8 units
or ‘OR’, which mean losses to the
firm, the marginal revenue for this
output is ‘RB’ but marginal cost is
higher at ‘RC’.
• Therefore, if the firm produces
Output
‘OR’, it will incur a loss indicated by
the triangle ‘ABC’
Equilibrium of a firm under perfect competition
through MC & MR

• The first and essential condition

of equilibrium of a firm is the
equality of MR and MC.
• It is necessary that beyond the
point of equilibrium, MC must be
higher than MR
• If MC is lower than MR beyond
the point of equilibrium, the firm
will like to produce more so as to
secure profits
• The MC curve should cut MR
curve from below as shown in
Output
figure
Equilibrium of a firm under perfect competition through MC & MR
• The MC curve cuts the MR curve at two places. At
point ‘A’ it cuts from above and at point ‘B’ from
below.
• Therefore, there are two points of equilibrium ‘A’
and ‘B’
• Before point ‘A’ MC is higher than MR which means
loss. So, point ‘A’ cannot be a determinate
equilibrium point
• Beyond point ‘A’ the MC is lower than MR and the
firm can go on producing till it reaches ‘OR’ amount.
• The determinate equilibrium point is, therefore, ‘OR’
or ‘B’ for beyond that point marginal cost is higher
than marginal revenue.
Output • We can conclude, therefore, that the equality of MC
and MR is not a sufficient condition of firm's
equilibrium and that it is necessary for the MC curve
to cut the MR curve from below for determinate
equilibrium
 Different Cost Conditions: Equilibrium of the Firm
under perfect competition in short run

• The short run equilibrium of firms when they are

working under different cost conditions
• Difference in the quality of raw materials used by the
various firms,
• Differences in production techniques,
• Differences in efficiency of managers employed by them,
• Differences in the size of plants built by them and
• Differences in the ability of the entrepreneurs
themselves account for the differences in costs of the
various firms
For all the firms, Marginal Revenue (price) equals the
Marginal Cost at equilibrium output.

Firm ‘A’ Firm ‘B’ Firm ‘C’

In firm ‘A’ where, In firm ‘B’ where, In firm ‘C’ where,

MR=MR MR=MR MR=MR
Production 100 Production 500 Production 1000
.

Firm ‘A’ Firm ‘B’ Firm ‘C’

Normal profit Supernormal Losses

profit AC is always
MR=MC=AC AC is always less more than
than MR & MC
MR & MC
 Long Run Equilibrium under Perfect
Competition
Short Run Long Run

Price=
-------

• The price and quantity combination corresponding to the equilibrium

point ‘P’ shows the actual magnitudes as determined by the market.
• No other combination of price and quantity of the commodity at
which the willingness or intentions of buyers and sellers will be
identical.