Perfect competition – Example

Perfect competitive market structure is a type of market structure where prices are dictated by the market forces i.e. the forces of demand and supply. The firms in this industry will therefore be price taker and the market is the price setter. This is the most economical type of market structure in terms allocation of resource. Perfect competition will exist when there are both information and allocation efficiency. The price determination under the perfect, market will exist where the supply and the demand curve meets. The industry has to therefore adjust its output to the ruling market prices. The implication of this is that the average revenue is equal to the marginal costs. If we assume for example that the demand is decreasing  by 2 units from 100 up to a maximum of zero units, when prices increases from zero to 20 units .We also assume that  the supply Is increasing from 0 to 100 when the prices increase from zero to 20.If we suppose that the point of intersection between the demand curve and the supply curve is at Price of 40 then we choose the corresponding amount of quantity at intersection  to be supplied by the company  as the equilibrium quantity the industry should supply to the market. Therefore price determination is done by the market and no individual firm can influence the market to   increase prices to more than 20.The individual firms demand curve will be equal to 20 since the quantity demanded under a perfect market is equal to the price of that commodity. The marginal revenue and the average costs will also be 20 since the marginal revenue, the average revenue, the prices and the quantity demanded are equal under the perfect competition market.

The equilibrium point under the perfect competition is the point where there is no tendency to increase or decrease the supply or the demand. From the example on the equilibrium point we have seen that the marginal revenue is 20 units. Then the marginal costs that a firm will incur under equilibrium point will be 20. The marginal cost curve is concave to the x axis and therefore cuts the marginal revenue twice. One is from above and the other one from below. Therefore we have two marginal revenue and marginal costs intersection point. The equilibrium point is where the marginal costs curve cuts the marginal revenue (at 20 units) from below. When the costs of the firm are between zero and twenty the firm will continue to produce more units until the costs equals to 20 units. If the firm cost was greater than 20 then the firm will have to reduce the cost to 20 for it to reach an equilibrium point. The equilibrium point is the point where the firm is making the maximum possible profits hence every firm most aim at reaching this point. In the short run the firms costs can be below 20 hence the firm will be making abnormal profits. The cost can be greater than 20 hence the firm will be making loss. The cost can be equal to marginal revenue this way the firm is making normal profits but in the long run the marginal costs are equal to marginal revenue hence the company will only be making normal profits.

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