Equilibrium Price and Output Determination Under Perfect Competition

Short Run Equilibrium

In the near run, market supply cannot be adjusted to reflect changes in market demand. It is because there aren't enough units or inputs available to change their capacities. An industry is meant to be a collection of businesses in a perfect competitive environment. The cost of the good is decided upon when the market finds equilibrium. The equilibrium of the industry is subject to two requirements. As follows:

• Market demand equal market supply
• All firms are in equilibrium.

However, because the firm gets its price from the industry in a situation of perfect competition, the firm should choose the output level. Under perfect competition, the lone firm is viewed as a price taker. A company may be in balance without necessarily making an extra profit. The degree of average cost in the short run equilibrium determines whether the firm generates extra profit or losses. They are as follows:

• If AR = AC, the company must make a regular profit.
  If AR > AC, it means the company made more money (or supernormal profit).
  If AR < AC, the company must be losing money.

Long Run Equilibrium

In the long run, market supply can be changed to reflect changes in market demand. It is because there are enough units or inputs available with different capacities. The minimum point of a corporation's long-term average cost curve, which is (at this time) tangent to the demand curve (AR) determined by the market price, is the point at which a firm has changed its plan to produce in equilibrium over the long term. In the long run, the company will only make regular profits, which are already factored into the long-run average cost. It results from ideal competition, which allows for free entry and exit of businesses.

The company's short-term supernormal profit serves as a lure for new businesses to enter the market, which enhances industry supply and causes market prices for all businesses to decline until only normal profits are generated.

Benefits of the Perfect Competition

According to this argument, perfect competition will produce the following welfares or advantages:

• It is assumed that each seller and buyer is fully or perfectly aware of the state of the market. Consequently, there are no information leaks or failures.
• Every company has the freedom to enter or exit the market. Simply put, there are no entry-level obstacles or restrictions in the market.
• No company may benefit from the monopoly power.
• Businesses can only profit normally.
• There is no requirement that the producers invest in the advertisement. because businesses can sell all of their output and there is perfect or complete knowledge.
• maximal potential for economic welfare and consumer surplus under ideal competition.
• In the ideal competition, there is maximum productive and allocative efficiency:
• The equilibrium point at which P = MC will take place is referred to as allocating efficiency.
• Long-term equilibrium, also known as productive efficiency, will happen at the output when MC = ATC.
• The consumer has a variety of options. It raises the degree of customer happiness.

How realistic is the model?

In the actual world, few few marketplaces or sectors are completely competitive. Consider how homogenous the output of actual organizations is, considering that even the tiniest manufacturing or service companies make an effort to differentiate their offerings.

Behavioral economists, who have gained more and more clout over the past ten years, challenge the notion that producers and consumers make logical decisions. Numerous studies have shown that making decisions frequently deviates significantly from what would be considered to be absolutely reasonable. When consumers and producers are presented with complex situations, decision-making can be prejudiced and prone to "guidance" from rules of thumb.

Despite being impractical, it still serves as a valuable model in two ways. First off, many primary and commodity markets, like those for coffee and tea, show several signs of perfect competition, including the existence of numerous independent producers and their incapacity to affect market prices. Second, the model serves as a helpful benchmark by which economists and regulators can assess the levels of competition that exist in actual marketplaces for various markets in manufacturing and services.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan