Market price of a commodity in perfect competition

In a perfectly competitive market, the market price of a commodity is determined by the forces of supply and demand. Perfect competition is characterized by a large number of buyers and sellers, homogeneous products, perfect information, and free entry and exit of firms. Under perfect competition, no individual firm has the power to influence the market price. The market price is determined solely by the interaction of supply and demand.

Determinants of market price

The market price of a commodity in perfect competition is determined by the equilibrium between the quantity supplied and the quantity demanded. This equilibrium is established at the point where the market demand curve intersects with the market supply curve. The quantity at this point is known as the equilibrium quantity, and the price at this point is the equilibrium price.

Minimum average cost of production

The minimum average cost of production refers to the lowest average cost at which a firm can produce a commodity in the long run. It is the cost per unit of output that minimizes the average cost curve. The average cost includes both fixed and variable costs, such as wages, rent, and raw materials.

Long-run equilibrium in perfect competition

In the long run, firms in perfect competition aim to minimize their average costs in order to maximize their profits. If a firm's average cost is higher than the market price, it will be unable to compete with other firms in the industry. In the long run, firms that cannot cover their costs will exit the market, reducing the supply of the commodity.

Firms that have lower average costs will continue to produce and supply the commodity at the prevailing market price. This process of entry and exit continues until all firms in the industry are operating at their minimum average cost of production. At this point, the market is said to be in long-run equilibrium.

Market price equal to minimum average cost of production

In perfect competition, the long-run equilibrium market price is equal to the minimum average cost of production. This is because firms in the industry cannot sustain prices below their average costs in the long run. If the market price is higher than the minimum average cost, firms have an incentive to enter the industry, increasing the supply and driving down the price. On the other hand, if the market price is lower than the minimum average cost, firms will exit the industry, reducing the supply and driving up the price.

Therefore, in the long run, the market price of a commodity in perfect competition tends to equal the minimum average cost of production. This ensures that firms in the industry are able to cover their costs and earn a normal profit.