F.Y.B.Com Semester II Business Economics II
Q.3
Explain the short run equilibrium of the firm under perfect competition.
ANS:
The short
run is a period of time within which the firms can change
their level of output
only by increasing or decreasing the amounts of variable factors such as labour
and raw material, while fixed factors like capital equipment, machinery, etc.
remains unchanged.
In other
words, short run is the conceptual time period where at least one factor of
production is fixed in amount while other factors are variable.
A firm in
short run is in equilibrium at a point where Marginal Revenue (MR) is equal
Marginal Cost (MC) i.e. MR=MC and where +MC is increasing at the point or MC is
cutting MR from below.
The firm
under perfect competition operates under the Ushaped cost curve. Since marginal
revenue is the same as price or average revenue under perfect competition, the
firm will equalise marginal cost with price to attain the equilibrium level of
output. A firm under perfect competition in short run being in equilibrium does
not necessarily earn profit. The firm determines the equilibrium level of
output and price and tries to earn excess profit, normal profit or may even
incur loss. The Diagram 9.3 which is given below will explain the firm’s
equilibrium situation in the short run.
In the above
fig Level of output is determined on the X axis and price on the Y axis.
The firm may
face excess profit, normal profit or even loss can be understood by the given
fig above.
1. Excess
Profit: OP is the
price at which the firm sell its OQ level of output. Where, E is the is the
equilibrium point where Marginal Cost is equal to Marginal Revenue (MR=MC) and where
MC is increasing which fulfils the condition.
Now to
determine the firm’s level of profit we calculate:
Profit = TR-TC
Where, TR =
P ×Q
Where, TR is
the total revenue which a firm earns by selling the output, P, is the price per
unit sold and Q is the quantity sold. So, in the above fig,
TR = OP × OQ
= OQEP.
TC = Q ×
Revenue/ Cost.
Where, TC is
the total cost
TC = OQ ×
OQRS
Therefore,
Profit = TR
– TC
= OQEP – OQRS
=SREP
Thus, the
firm in the short run when the price is OP is at the equilibrium and earns SREP
amount of profit which is the excess profit which is also called as super
normal profit.
2. Normal
Profit: the perfect
competitive firm may also earn normal profit in the short run if he fails to
earn the super normal profit. In the above fig 9.3 if the firm is in
equilibrium at the point E1 where OP1 is the price and OQ1 is the level of
output. The firm is at the position where he earns normal profit.
Profit = TR
– TC
Where, TR = P ×Q
= OP1 ×OQ1
= OQ1E1P1
TC = Q ×
Revenue/ Cost
= OQ1 × E1P1
= OQ1E1P1
Therefore,
Profit = TR
– TC
= OQ1E1P1 - OQ1E1P1
= Normal Profit.
Thus, the
firm at price OP1 earns Normal profit. Normal profit is the profit which a firm
must get to survive into the business where he can produce the same level of
output in future with the amount of revenue he earns. It is a situation of no profit
no loss. If the firm unable to make a normal profit he may go into loss.
3. Loss
or Sub-normal profit:
when a firm fails to earn even normal profit and still continue to operate his
business by incurring into loss. Such situation can be explained as flow:
The firm is
equilibrium at the point E2 where OP2 is the market price and OQ2 is the level
of output.
Profit = TR
– TC
Where, TR = P ×Q
= OP2 × OQ2
= OQ2E2P2
TC = Q × Revenue/ Cost
= OQ2 × US
=OQ2US
Loss =
P2E2US
4. Shut
down point: When the
firm not even able to earn variable cost he better tries to shut down his
business or stops operating for that particular time.
In the above
Diagram 9.4 when the price is OP, the firm produces the equilibrium level of
output which is OQ at that price and at that volume of output the firm total
revenue (TR) is OQRP and his Total Variable Cost (TVC) is OQSN so the loss
which firm gets in terms of variable cost is PRSN. His total loss is PRUT of which
PRSN is variable cost and NSUT is the fixed cost. At this time, it is better
for a firm to either shut down his business or to wait for a time when the
price goes up for his commodity where at least he can cover up his Total
Variable Cost. It is because that variable cost enables the firm to operate in
his business.
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