Question

What is perfect competition? How the equilibrium price and output in the short and long run can be decided by a firm. Justify the answer by drawing the right graphs.

Answer 1

Perfect Competition refers to a market situation where there are a large number of buyers and sellers and where the sellers sell homogeneous products. One can say that it is an extreme case of zero market power of the firm where there is an absence of rivalry between firms.

Determining equilibrium price and output in the short run:

A firm in the short run may face any of the three situations. These are:

1. A firm may earn supernormal profits because in the short run new firms cannot enter the industry

2. A firm may earn normal profits.

3. A firm may suffer minimum losses because in the short run firm may not stop production even when the price of the product falls.

Determining equilibrium price and output in the Long run:

Long-period refers to that period in which the producers get sufficient time to adjust their supplies. In the long run, all firms in equilibrium will earn only normal profits. The long-run equilibrium output of the firm is called optimum output because the price of this output is equal to the minimum long-run average cost and the firm earns just normal profits.