Perfect Competition

Characteristic
Perfect competitive is a market in which many firms in the market produce standardized or
homogeneous product. This means commodities of all firms are identical, no quality differences,
no brand names, no advertising. All buyers and sellers are well informed about markets and
prices. If there are any changes in price, both producers and customers will be aware about that.
In perfect competition, firms can freely entry into and exist from the market. Moreover, no
individual seller or buyer can influence price because there are so many firms.
Short run and long run profit


In the short run, it is possible for firms to earn
supernormal profit in perfect competition because
short run is a time period that at least one FOP are
fixed and it is too short for others firms to entry the
market even though there is no barriers to entry. In
perfect competition, firm maximize profit by
producing at the level of output where MC = MR.
Firm produces at Q out and charge at the price
which is determined by the demand curve at P. at
the price P, firm is able to cover its ATC and earn
SNP which equal ABP1P.

However, in the long run which is a period of time
which is enough for other firms to entry in the
market to and compete profit away. Economics
profit will attract other firms to come into the
market. As others firm entry the market, it will shift
the market supply curve to the right causing the
market price to fall from P to P1until the profit
disappears. As the result, firm is no longer making
economic profit; there will be no incentive for new
firms to enter the market. This is the long run
equilibrium position for a firm operating in perfect
competition. Firm will maximize profit by producing
where MC = MR. As Q1 outputs are produces, firm will charge at the price P1. At this P, P intersects
firm AV, firm is in equilibrium.

Loss minimization or shutting down
In the short run, perfectly competitive firms may experience a loss. Firm may choose to keep
operating or shutting down.








In short run, if firm considers shutting down as the price which is higher than its variable costs, its
output equals to zero. There will be no variable costs and no revenue but firms have to continue
to pay its fixed costs which equal to AXTB because it is impossible for firms to dispose its fixed costs
in the short run. However, if firm chooses to remain in the industry, the firms loss is AXZP which is
cheaper than the fixed costs. At the price P, it is not high enough to cover ATC but firms revenue
is sufficient to pay all variable costs and a part of fixed costs. Therefore in short run, it is better for
firm to produce at the quantity where marginal cost equals to marginal revenue than produce no
output, no revenue and incurring a loss equals to total fixed costs.

Nevertheless, if the price drops from P to P1 where the price is lower than firms AVC, firm should
close its production because firm does not receive sufficient revenue to pay for the ABC at any
level of output. In this case, as firm produces any level of output will make a loss that is greater
than produces nothing. If firm shuts down, its minimum loss is only the total fixed costs.
Efficiency
Firm in perfect competition is said to achieve productive efficiency in the long run. In the run,
each good will be produced at least cost. Competitive firms must produce at the minimum point
of the ATC curve to survive by using resources in the most efficient way because there are
numerous of producer who sells identical products.

Firm under perfect competition also attain allocative efficiency which can be achieved when
resources are used to produce a particular mix of goods most wanted by society.
Competitive firms maximize profit by producing the level of quantity at where MR = MC. However,
under perfect competition, AR (P) equals to MR and thus P equals MC.

Nevertheless, PC does not achieve dynamic efficiency which occurs when the firm undertakes
research and development to discover new products, make improvements to existing
products and find new production processes that save time and reduce costs. This is
because there is no restriction of barriers to entry, firm only make normal profit in the long run
which means that firm does not have sufficient funds to spend on R & D and other firms may copy
any firms innovation.