A market is perfectly competitive if There are large number of sellers and buyers of the commodity – therefore no individuals can influence price Homogeneous products across all firms in the industry. Perfect mobility of resources. All the economic agents (consumers, producers, factor owners) in the market have perfect knowledge of present and future prices and costs

1. PERFECT COMPETITION

2. Perfect Competition
A market is perfectly competitive if
▪ There are large number of sellers and buyers of the
commodity – therefore no individuals can influence price.
▪ Homogenous products across all firms in the industry.
▪ Perfect mobility of resources.
▪ All the economic agents (consumers, producers, factor
owners) in the market have perfect knowledge of present
and future prices and costs.

3. Perfect Competition
In such a perfectly competitive market, the
price of the commodity is determined
exclusively by the intersection of the
market demand curve and market supply
curve for the commodity. Here the
producer/seller/firm is a price taker and
can sell any amount of the commodity at
the established price.

4. Short-run Equilibrium
▪ To determine the equilibrium of the industry first of all we need to
derive the market supply.
▪ This requires the determination of the supply of the individual firms,
since the market supply is the sum of the supply of all firms in the
industry.
▪ In a firm 𝜋 = 𝑇𝑅 − 𝑇𝐶
▪ Normal rate of profit is included in the cost items of the frim.
▪ 𝜋 is considered as profit above normal profit.
▪ The firm is in equilibrium when it produces the output that maximises
the difference between total receipts and total costs.

5. ▪ The equilibrium of the firm may be shown graphically using the 𝑇𝑅 and 𝑇𝐶 curves,
or the 𝑀𝑅 (Marginal Revenue) and 𝑀𝐶 (Marginal Cost) curves.
Short-run Equilibrium
C
R
0 XA Xe XB X
TC
TR
πMAX

6. Short-run Equilibrium
The TR-TC approach is not appropriate if the firms are combined together in the study
of the industry. The alternative approach is based on marginal cost (MC) and marginal
revenue (MR).
C
P
P
A
Xe
SMC
SATC
P = MR = AR
e
0
X
B

7. Short-run Equilibrium
(a) 𝑀𝐶 < 𝑀𝑅 => Total profit is not maximised and expansion of output is possible.
(b) 𝑀𝐶 > 𝑀𝑅 => Total profit is being reduced and the firm tries to reduce level of output.
(c) 𝑀𝐶 = 𝑀𝑅 => short run profit is maximised.
The requirements for the equilibrium of the firms
(1) 𝑀𝐶 = 𝑀𝑅
(2) 𝑆𝑙𝑜𝑝𝑒 𝑜𝑓 𝑀𝐶 > (𝑠𝑙𝑜𝑝𝑒 𝑜𝑓 𝑀𝑅) that is, 𝑀𝐶 must cut from 𝑀𝑅 curve from below (𝑀𝐶 should be
rising at the point of its intersection with the 𝑀𝑅 curve).

8. Shutdown Point
▪ The firm in equilibrium does not assure that it makes excess profits.
▪ The firm makes excess profits or losses depends on the level of the 𝐴𝑇𝐶 at the
short-run equilibrium
C
P
P
F
Xe
SMC SATC
P = MR = AR
e
0
X
C
▪ If the 𝐴𝑇𝐶 is above the price at equilibrium
the firm makes a loss (equal to the area
𝐹𝑃𝑒𝐶)
▪ In this case the firm will continue to produce
only if it covers its variable costs.
▪ Otherwise, its better closedown.
▪ The point at which the firm covers its variable
costs is called the shut-down point.

9. Shutdown Point
▪ The shutdown point is denoted
by point 𝑤
▪ If price falls below 𝑃𝑤 the firm
does not cover its variable
costs and is better off if it
closes down.
C
P
Pw
Xw
SMC
SATC
w
0
X
SAVC
AFC

10. Derivation of Supply Curve
▪ The supply curve of the firm may be derived by the points of intersection of its 𝑀𝐶
curve with successive demand curves.
▪ Gradual increase in market price causes an upward shift of the demand curve of the
firm
▪ Given the positive slope of the 𝑀𝐶 curve, each higher demand curve cuts the 𝑀𝐶
curve to a point which lies to the right of the previous intersection.
▪ This implies that the quantity supplied by the firm increases as price rises.
▪ The firm given its cost structure, will not supply any quantity (will shut down) if the
price falls below the shutdown point
▪ At a lower price (price below the shutdown point (the point where the average
revenue is below average variable cost) the firm does not cover its variable costs .

11. Derivation of Supply Curve
▪ The supply curve of the individual firm is derived by adjoining the successive points of
intersection of 𝑀𝐶 and the demand curves which is identical to its 𝑀𝐶 curve to the right of the
shut-down point 𝑤.
▪ Below 𝑃𝑤 the quantity supplied by the firm is zero. As price rises above 𝑃𝑤 the quantity
supplied increases.
C
P
Pw
Xw
SMC
SATC
w
0
X
SAVC
X1 X2
P1
P2
C
P
Pw
Xw
S
w
0
XX1 X2
P1
P2

12. Supply Curve and the short run equilibrium of the industry
▪ The industry supply curve is the horizontal summation of the supply curves of the
individual firms
▪ Suppose, factor prices and the technology are given and there are large number of firms
▪ Then the total quantity supplied in the market at each price is the sum of the quantities
supplied by all firms at that price
▪ Thus The industry supply curve is shown as a straight line
C
P
P
A
Xe
SMC SATC
P = MR = AR
e
0 X
B
C
P
P
F
Xe
SMC SATC
P = MR = AR
e
0 X
C
0
X
B
P
Q

13. Supply Curve and the short run equilibrium of the industry
▪ Given the market demand and market supply, the industry is in equilibrium at which the quantity
demanded is equal to the quantity supplied in the industry
▪ The industrial equilibrium output is ത𝑄 and price is ത𝑃
▪ This is short-run equilibrium and at the prevailing market price some firms may face excess
profits and some firms may face losses
▪ In the long run, those firms make losses will shut-down their plant and the presence of excess
profit may attract new firms into industry.
▪ Therefore, in the long run the industry will lead to a long-run equilibrium in which firms will just
be earning normal profits and there will be no entry to and exit from the industry.
C
P
P
A
Xe
SMC SATC
P = MR = AR
e
0 X
B
C
P
P
F
Xe
SMC SATC
P = MR = AR
e
0 X
C
0
X
B
P
Q

14. Equilibrium of the firm in the long run
▪ In the long run firms are in equilibrium when they have adjusted their plant so as to
produce at the minimum point of their long run 𝐴𝐶 curve, which is tangent to the demand
curve.
▪ In the long run the firms will be earning just normal profits, which are included in the 𝐿𝐴𝐶.
▪ New firms will be attracted to the industry, if they make excess profits and this results a
fall in price (downward shift in the individual demand curves)
▪ Simultaneously there will be an upward shift of the cost curves due to the increase of the
prices of factors as the industry expands. These changes will continue until the 𝐿𝐴𝐶 is
tangent to the demand curve.
▪ If the firms make losses in the long run they will leave the industry and simultaneously,
price will rise and costs may fall as the industry contracts, until the remaining firms in the
industry cover their total cost inclusive of the normal rate of profit.
▪ Thus a firm will remain in business in the long run only if its 𝑇𝑅 equals or is greater than
its 𝑇𝐶

15. Equilibrium of the firm in the long run
▪ Consequently, there will be increased supply in the industry and the supply curve will
shift towards right and price will fall until it reaches the level of 𝑃1 at which the firms and
the industry are in long-run equilibrium.
▪ 𝑳𝑴𝑪 = 𝑳𝑨𝑪 = 𝑷 and in more detail 𝑺𝑴𝑪 = 𝑳𝑴𝑪 = 𝑺𝑨𝑪 = 𝑳𝑨𝑪 = 𝑷 = 𝑴𝑹
LAC
LMC
SACSMC
SAC1SMC1
P
P1
P
C
X0
P
P
P1
Q Q10 X
S
S1
▪ If the price is 𝑃, the firm is making
excess profits working with the plant
whose cost is denoted by 𝑆𝐴𝐶1.
▪ The firm now has an incentive to build
new capacity and it will move along its
𝐿𝐴𝐶.
▪ At the same time new firms will be
entering the industry attracted by the
excess profits

16. Equilibrium of the industry in the long run
▪ The industry is in long run equilibrium when a price is reached at which all firms are
in equilibrium
▪ At the equilibrium level all firms are producing at the minimum point of their 𝐿𝐴𝐶
curve and making just normal profits
▪ Under these conditions there is no further entry or exit of firms in the industry, given
the technology and factor prices.
LAC
LMC
SACSMC
P
P
C
X0
P
P
Q0 X
S’
X
Industry Firm
P = MR
D
D’
S
▪ At the market price, 𝑃, all the firms
produce at their minimum cost, earning
just normal profits and the firms are in
equilibrium at the level of output 𝑋
𝐿𝑀𝐶 = 𝑆𝑀𝐶 = 𝑃 = 𝑀𝑅

17. Equilibrium of the industry in the long run
▪ At the market price, 𝑃, all the firms produce at their minimum cost, earning just
normal profits and the firms are in equilibrium at the level of output 𝑋
𝑳𝑴𝑪 = 𝑺𝑴𝑪 = 𝑷 = 𝑴𝑹
▪ At price 𝑃, the industry is in equilibrium because profits are normal and all costs are
covered so that here is no incentive for entry or exit.
𝑳𝑨𝑪 = 𝑺𝑨𝑪 = 𝑷
LAC
LMC
SACSMC
P
P
C
X0
P
P
Q0 X
S’
X
Industry Firm
P = MR
D
D’
S
▪ With all firms in the industry being in
equilibrium and with no entry or exit,
the industry supply remains stable,
and, given the market demand (𝐷𝐷’ in
Figure 12) the price 𝑃 is a long run
equilibrium price.

18. Producer’s Surplus
Producer’s surplus is the difference between what producers are
willing and able to supply a good for and price they actually
receive.Price
B
Supply
A
C
Q1 Quantity
The producer’s surplus, is the area
between the price line and the supply
curve. It indicates the excess of revenues
over cost of production

19. Producer’s Surplus
Price
B
S1
A
C
Q1 Quantity
S2
F
E
G
Q2
Price
B
S1
A
C
Q1 Quantity
S2F
E
G
Q2
D1
D2
Q2