Perfect competition is a market structure with large number of buyers and sellers. There are no barriers to entry into the industry. Firms sell identical products that are perfect substitutes each other. In addition, they are well informed about prices and no have government intervention. Transport cost is negligible hence do not affect pricing. Price determined by the market must be accepted by the buyers and sellers. They are said to be price takers. Therefore, firms have no market power. Each firm in perfect competition seeks to maximize their profit, which equals total revenue minus total cost. Total revenue for a firm is the selling price times the quantity cost [ TR=(P*Q) ] . Total cost is the opportunity cost of production, which includes normal profit. Average revenue tells us how much revenue a firm receives for the typical unit sold. The average revenue equals the price of the good in perfect competition. Marginal revenue is the change in total revenue from an additional unit sold. For competitive firm, marginal revenue equals the price of the good.
In the short run, firms can make super-normal profits or losses under perfect competition. The firm has fixed resources and maximizes profit or minimizes loss by adjusting output. When a firm operates in a perfectly competitive market, its supply curve is its short-run marginal cost curve above average variable cost. The firm should not produce, but should shut down in the short run if its loss exceeds its fixed costs. By shutting down, its loss will just equal those fixed costs. The shut down point is the level of output and price at which the firm just covers its total variable cost. For perfect competition, marginal revenue is equal to price as the firm is facing a perfectly elastic demand.
Entry and exit is possible in the long run of perfect competitive. Long run firms are attracted into the industry if the supernormal profits are making by the...
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