The Theory of the Firm under Perfect Competition Class 12 Economics

Market

A system or structure is in place that facilitates the connection between individuals or entities interested in purchasing or selling a particular product or service, enabling them to finalize transactions at mutually acceptable rates.

Perfect Competition

Perfect competition is a market arrangement where numerous buyers and sellers compete for identical products at the same price, and there is no government intervention, with free entry and exit for firms. Since prices remain constant, the average and marginal revenue curves coincide, meaning they are equal and parallel to the x-axis. The industry determines the price based on market demand and supply, and no single entity can control the price of the product. Firms can only make decisions on output, leaving the industry to set the price, which the firm must accept.

Features of Perfect Competition

In a perfectly competitive market, several characteristics exist. Firstly, there are a large number of small sellers who offer homogenous products to buyers, and no single firm can significantly impact the market price or supply. Additionally, each firm is a price taker, meaning they have no control over the price of the commodity they are selling. Furthermore, consumers and producers have perfect knowledge about the market, so no one is willing to buy or sell below or above the market price. Free entry and exit also exist in the market, which means that new firms can enter and existing firms can exit without any obstacles. When existing firms earn abnormal profits, new firms are attracted to enter, increasing market supply and decreasing market price. Similarly, when firms experience losses, they can exit the market, decreasing market supply and increasing market price until only normal profits remain for the remaining firms.

Revenue

The term refers to the income generated by a business entity through the provision of goods or services to its customers.

Total Revenue (TR) 

• The price (p) of the commodity is multiplied by the amount produced and sold to determine revenue (q). 
• Total revenue (TR) is defined as
  TR = p × q in algebraic form.

Total Revenue Curve

A curve represents the relationship between a firm's total revenue from selling its output and the quantity of output sold. This curve is used along with the firm's total cost curve to determine the profit-maximizing level of production and economic profit.

Average Revenue:

• Average revenue refers to the amount of income a company earns for each unit of output sold.
• Put simply, it is the profit a seller makes on each unit of the product sold.
• To calculate average revenue, one would divide total revenue by total output.
  

Marginal Revenue:

• Marginal revenue refers to the increase in revenue generated by selling one more unit of a commodity.
• Each additional unit sold in the market can cause a change in total revenue.
• The relationship between market price and marginal revenue can be expressed using the following equations:
  
  Where
  TR = Total Revenue
  MR = Marginal Revenue
  Q = Quantity
• In a perfectly competitive market, the price equals marginal revenue,

  according to the preceding equation.
  MR = PQ_n - PQ_n

 Profit Maximisation

• An equilibrium state is said to be achieved by a producer when they aim to maximize profits or minimize losses.
• The condition for profit maximization is when a producer reaches a point where Marginal Revenue (MR) is equal to Marginal Cost (MC). Alternatively, MC should either be increasing or intersecting MR from below.
• A producer is considered to be in a state of equilibrium if they strive to maximize their earnings or minimize their losses, which is achieved when MR is equal to MC, or when MC intersects MR from below as it rises.

Supply

Supply is the term used to describe the quantity of a particular commodity that businesses are willing and able to offer for sale in the market at a given price during a specific time period.

• Supply Schedule: A supply schedule is a chart that presents the quantities of a product that a company is willing to sell at different prices, while holding constant the prices of production factors and the technology used.
• Supply Curve: A firm's supply curve illustrates the amount of output it chooses to produce in response to various market prices, while keeping technology and factor prices constant.
• Short-run Supply Curve of a Firm: The short-run supply curve of a firm shows the quantity of a good that a profit-maximizing company is willing to produce at each price point. This curve is less elastic, indicating that it cannot respond easily to changes in demand for goods and services.
• Long-run Supply Curve of a firm: The long-run supply curve of a firm is the quantity of goods that can be supplied when all inputs are variable. It is more elastic than the short-run supply curve, and the long-run average cost curve encompasses the short-run average cost curves in a U-shaped curve. Additionally, with increasing long-run marginal cost curves, the supply curve becomes upward sloping.

Determinants of Supply Curve

• Private businesses primarily aim to maximize profits, and higher production costs can limit the supply by reducing profits. Factors that influence production costs include input prices, salary rates, government regulations, and taxes.
• Technological advancements can help decrease production costs and increase profits, leading to an increase in the supply of goods or services.
• As more sellers enter the market, the supply of goods or services increases due to an increase in the number of vendors.
• Producers may choose to hold onto their inventory and delay selling their products if they anticipate higher future prices, allowing them to profit from the price increase. This can affect the market supply.

Market Supply Curve

The market supply curve reflects the relationship between the overall production level and the average marginal cost of producing that level of output.

Price Elasticity of Supply

• Price elasticity of supply refers to the degree to which the quantity of a particular good or service is responsive to a change in its price.
• The price elasticity of supply is a measure of the extent to which the amount of a product supplied changes in response to a change in its price.
• The price elasticity of supply can be represented by a curve known as the price elasticity of supply curve.
  
  Where
  ΔQ = change in quantity of the good supplied to the market as market
  ΔP = change in price of the good

Equilibrium Price

• Equilibrium occurs when the quantity of goods or services supplied is equal to the quantity of goods or services demanded.
• The state of equilibrium in a market exists when the forces of supply and demand are balanced, resulting in an equal quantity of goods or services being supplied and demanded.
• In a market where a major index is moving sideways or consolidating, supply and demand forces are regarded as being in a state of approximate balance, indicating a condition of market equilibrium.

Equilibrium Quantity

• Equilibrium quantity refers to a state in which there is neither a shortage nor a surplus of a product in the market.
• When the amount of a product that consumers demand is equal to the amount that producers are willing to supply, the market is in a state of equilibrium.

Maximum Price Ceiling: 

• The government may impose a maximum price ceiling when the demand for essential goods or services surpasses the supply, causing shortages and excessive market prices. This is done for the benefit of consumers and may involve rationing or dual marketing to address the excess demand.
  

Minimum Price Ceiling: 

• A price floor is a government-imposed minimum price that producers are not allowed to sell their goods below. If the government decides that the equilibrium price is too low to cover the production costs, it may set a price floor higher than the equilibrium price to prevent potential losses for producers. This price is also referred to as the minimum support price.
• When the government sets a price floor, producers are not permitted to sell their goods below a certain price level. This is done to prevent prices from falling below a certain point, which would be detrimental to producers. The government may purchase the surplus supply at the price floor, which is often referred to as the minimum support price or the floor price.
  

Technological Advancement on Supply Curve:

• Technological advancements often lead to lower marginal costs of production, which enables producers to produce more goods and services using the same amount of resources. This results in a rightward shift of the supply curve and a downward shift of the marginal cost curve.
• The relationship between supply and technological growth is positive. As technology advances, production costs are often reduced, allowing producers to increase the quantity of goods and services they supply at any given price. This results in a shift of the supply curve to the right.
• Accessible factors of production and technological advancements can enable producers to generate more goods and services at a lower marginal cost. This leads to a rightward shift of the supply curve and a downward shift of the marginal cost curve.
• When technology advances, production costs are often reduced, which allows producers to produce more goods and services at the same price. This results in a shift of the supply curve to the right, leading to an increase in the quantity of goods and services supplied.