Price Determination and Equilibrium of the Firm in Short Run under Perfect Competition

Perfect competition is a market structure where a large number of buyers and sellers participate in the exchange of homogeneous products. In this market structure, no single firm has the power to influence the market price. The process of price determination and equilibrium of the firm in the short run under perfect competition is explained below.

Determining the Market Price

In perfect competition, the market price is determined by the forces of demand and supply. The demand for a product is the quantity of the product that buyers are willing and able to purchase at a given price. The supply of a product is the quantity of the product that sellers are willing and able to sell at a given price. The intersection of the demand and supply curves determines the market price.

Equilibrium of the Firm

In the short run, a firm in a perfectly competitive market can earn supernormal profits, normal profits, or losses. The equilibrium of the firm is determined by the intersection of the marginal cost (MC) curve and the marginal revenue (MR) curve.

- If the market price is greater than the average total cost (ATC), the firm earns supernormal profits. The firm will continue to produce as long as the marginal cost is less than the market price.
- If the market price is equal to the ATC, the firm earns normal profits. The firm will continue to produce as long as the marginal cost is equal to the market price.
- If the market price is less than the ATC, the firm incurs losses. The firm will continue to produce as long as the marginal cost is less than the marginal revenue.

In the short run, a firm can shut down or continue to produce. A firm will shut down if the market price is less than the average variable cost (AVC). If the market price is greater than the AVC but less than the ATC, the firm will continue to produce in the short run but will exit the market in the long run.

Conclusion

In conclusion, the process of price determination and equilibrium of the firm in the short run under perfect competition is determined by the forces of demand and supply. The market price is determined by the intersection of the demand and supply curves. The equilibrium of the firm is determined by the intersection of the marginal cost and the marginal revenue curves. A firm can earn supernormal profits, normal profits, or losses in the short run. The firm can shut down or continue to produce based on the market price and the average variable cost.