short run equilibrium of the firm under perfect competition: Business Economics 2021

short run equilibrium of the firm under perfect competition

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. remain unchanged.

In other words, the short run is the conceptual time period where the firm makes changes in variable factors and fixed factors remain unchanged.

A firm in short run is in equilibrium at a point where Marginal Revenue (MR) is equal to 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 U-shaped cost curve. Since marginal revenue is the same as price or average revenue under perfect competition, the firm will equalise marginal cost with the 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 an excess profit, normal profit, or may even incur a loss.

short run equilibrium of the firm under perfect competition

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.

Excess Profit:

OP is the price at which the firm sells its OQ level of output. Where E is the equilibrium point where Marginal Cost is equal to Marginal Revenue (MR=MC) and where MC is increasing which fulfills 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 that 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 equilibrium and earns an SREP amount of profit which is the excess profit which is also called supernormal profit.

Normal Profit:

The perfectly competitive firm may also earn normal profit in the short run if it fails to earn the supernormal
profit. In the above diagram 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 in a position where it earns a 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 a Normal profit.

Normal profit is the profit that a firm must get to survive in the business where it can produce the same level of output in the future with the amount of revenue it earns. It is a situation of no profit no loss. If the firm is unable to make a normal profit it may go into loss.

Loss or Sub-normal profit:

when a firm fails to earn even normal profit and still continue to operate his business by incurring into a loss. Such a 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

References: IDOL Mumbai University Books

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