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SS2: ECONOMICS - 2ND TERM

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Short-run profit maximizing position of the perfect competitive firm. The firm achieve maximum profit at the point where marginal revenue is equal to marginal cost because price and marginal revenue are equal for the perfectly competitive market. The firm will be operating at the minimum level of shortrun average total cost since cost minimisation is part of profit maximisation.

Screen Shot 2020 12 31 at 6.58.37 PM

Short-run Profit Maximization of Perfect Competition Market

Profit maximizing implies that MR = MC and since P = MR, it means that profit is maximized where MC = MR. In the figure above the point of profit, maximization is Q1 and the output is q. The profit which is the abnormal profit is the shaded portion. At any output, less than qe MC < MR, the firm should increase output to make more profit.   At output greater than Q, MC > MR, the firm should reduce output to make more profit.

It is only at output qe where MC = MR, that the firm is said to maximize profit so at this point the firm does not show any tendency to either increase or reduce output.

Long-Run Equilibrium of the Perfect Market

In the long run, firms operating under a perfect competitive market realize zero or normal profit. This is so because the long-run period is a period long enough for resource allocation. If in the short run firms are making an abnormal profit, this will encourage more firms to join the industry. As they join, the profit margin of operating firms will continue to fall until firms operating make a normal profit and more firms will stop joining.

Similarly, if firms are making losses in the short run, some of the firms in the industry will start leaving. As they leave, losses in the industry will continue to reduce. Firms will continue to leave until those remaining are making normal or zero profit. In the long run under perfect competition

P = MC = MR = AR = D = AC

as shown below

Screen Shot 2020 12 31 at 7.21.07 PM

Evaluation Questions

1. Explain the Shortrun equilibrium of the perfect competitive market

2. List and explain four types of market based on the type of goods purchased and sold.

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