Perfect Competition - Essay Example

Perfect Competition al Affiliation: Perfect Competition In the long run, companies in the perfect competition earn just a reasonableprofit, hence their economic profit is zero. The entrance, exit, and change in size of firms results in the adjustments in the market supply curve. The long-run change goes on until the market demand curve intersects with the market supply curve. The point of intersection corresponds to the lowest point on each firm’s long-run average cost curve (LRAC). In the long run, competition forces a firm to adjust its scale until it achieves minimum average cost. The reason is that during the long-run period, all resources of a company are variable. A firm thus has to minimize its average costs during this time to enable it stays on the market under the prevailing competition. At the equilibrium point, marginal cost, price, short-run average total cost, and long-run average cost are all equal. Therefore, a firm in perfect competition in the long-run will not find any reason to change the quantity of its output (McEachern, 2014). Outside firms will not find any incentive to enter the industry since the existing firms are not earning the economic profit. In other words, all resources employed in this industry make their opportunity costs.
Suppose firms in an industry A are gaining economic profits, hence higher return than companies in another industry B in the same economy. Therefore, businesses in Industry B are undergoing economic losses because they are not getting as much as they could in industry A. Some companies in industry B will hence exit to join industry A. The process will go on until firms in both industries are getting zero economic profit. Thus, entry of companies into an industry will reduce economic profits to null in the long-run. For example, radishes price is $0.40 per pound. Mr. John’s average total cost is $0.26 per pound at an output of 6,700 pounds of radishes a month. Each unit will, therefore, bring a profit of $0,14 ($).40-$0.26). Mr. John thus gets a monthly profit of $938 ($0.40x 6,700) as shown in panel (b). Firms will enter the radish industry as long as they can make economic profits (as long as price is more than average total cost (ATC) in panel (b)), the supply curve moves right and the price falls. Marginal Revenue goes down to MR2 as price reduces (Cukrowski & Aksen, 2003). Mr. John will have to reduce his supply, shifting along the Marginal Cost (MC) curve to the minimum point on the ATC curve, at $ 0.22 a pound and an output of 5,000 pounds a month. Although individual firm’s output reduces as prices fall, firms that are more new are now in the industry, causing the output of the industry to rise to 13 million per month in panel (a).
Fig. 1: How entry of firms into a company minimizes economic profit
On the other hand, the exit of firms from an industry gets rid of economic losses. In fig. 2 panel (a), the market price P1 of an industry is below ATC. In panel (b), an individual firm produces a quantity q1 at price P1, with an assumption that it is covering its average variable cost (Cukrowski & Aksen, 2003). The shaded part shows the losses of the firm. Some companies will decide to exit since they are losing money. The supply curve in (a) will move to the left as long as losses prevail. Eventually, price climbs to P2, supply goes to S2 and economic profits become zero.
Fig. 2: How exit of firms reduces economic losses
References
Cukrowski, J., & Aksen, E. (2003). Perfect competition and intra-industry trade. Economics Letters, 24(4), 20-31.
McEachern, W. A. (2014). Econ microeconomics 4. Mason, OH: South-Western Cengage Learning. Read More