Question

In a perfectly competitive market, each firm produces at a quantity where price is set

Group of answer choices

equal to average cost, both in the short run and in the long run.

equal to marginal cost, in the short run.

equal to average cost, in the long run.

equal to marginal cost, both in the short run and in the long run.

Answer 1

Profit(Pr) = TR - TC

where TR = Total Revenue = P*Q where P = price and is set by a market for a perfect competitive industry and this is independent of Output or quantity(Q) and TC = Total cost

Maximize : Pr

First order condition :

d(Pr)/dQ = 0 => P(dQ/dQ) - d(TC)/dQ = 0 => P - MC = 0 {Here MC = Marginal cost = d(TC)/dQ}

=> P = MC

Thus whether short run or long run, in perfect competitive industry each firm sets price equal to Marginal cost. But as in long run each perfect competitive firm earns 0 profit and thus P = AC where AC = average cost.(Note in long run P = AC and also P = MC. thus we have P = MC = AC and hence a long run price will be the price where MC = AC and this P = MC).

Hence, whether short run or long run, in perfect competitive industry each firm sets price equal to Marginal cost

Hence, the correct answer is (d) equal to marginal cost, both in the short run and in the long run.